When a debtor disposes of the secured party's original collateral, current law protects the secured party in two ways. In general, the security interest continues in the original collateral and can be enforced against the new owner. See current §9-306(2).¹ In addition, the security interest automatically extends to the proceeds received as a result of the disposition. See current §9-306. Although revised Article 9 generally continues both themes, it expands the definition of proceeds and thereby extends the reach of the secured party's automatic security interest in such after-acquired property. This column reviews the basic attachment rules for proceeds under revised Article 9. The perfection and priority rules for proceeds, as well as the bankruptcy-specific implications of these rules, will be analyzed in future columns.

The Basic Rule

Section 9-315 of the revised act addresses the secured party's rights upon disposition of the collateral. With several minor refinements, that section carries forward the rule under current law that, absent the secured party's consent, the security interest continues in the original collateral notwithstanding its disposition. Compare current §9-306(2) with §9-315(a)(1).² The revised act adds the terms "lease" and "license" to clarify that those types of transactions are dispositions covered by the rule. The revised act also clarifies that the type of secured party consent required to cut off the lien is not mere consent to a disposition, but rather consent to a "disposition free of the security interest."³ Interestingly, the revision does not attempt to resolve the frequently litigated question of whether a consent that is conditioned upon the secured party's receipt of the proceeds cuts off the lien. See §9-315, cmt. 2.

In addition to a continued security interest in the original collateral, the revised act also carries forward the current rule that the security interest automatically extends to any "identifiable proceeds" of the original collateral. See §9-203(f) and §9-315(a)(2). The attachment of the security interest to the proceeds is automatic. §9-315(a)(2). There is no need to include language in the security agreement granting a security interest in proceeds, nor is it necessary that the proceeds satisfy the description of collateral that is contained in the security agreement.⁴ See §9-203(f). Note that, although the revised act includes "agricultural liens" within its scope, the §9-315 proceeds rules do not apply to agricultural liens. See §9-315, cmt. 9. Thus, the relevant state's non-UCC agricultural lien laws will determine whether the lien extends to proceeds.⁵

The requirement that the proceeds be "identifiable" also has been clarified. Most courts interpreting current law allow the secured party to use equitable tracing devices such as the "lowest intermediate balance rule" to establish the identity of commingled proceeds,⁶ and the revised act expressly authorizes that practice. See §9-315, cmt. 3. For cash proceeds and other non-goods proceeds, the proceeds are "identifiable" and thus subject to the security interest "to the extent that the secured party identifies the proceeds by a method of tracing, including application of equitable principles, that is permitted under" non-Article 9 law for commingled property of that type. §9-315(b)(2). A different rule applies if the proceeds are goods that become commingled with other goods such that their identity is lost in the product or mass. In such a case, the "proceeds" security interest attaches to the entire product or mass. See §§9-315(b)(1) and 9-336(c).⁷

Finally, the revised act makes clear that the security interest attaches to the proceeds of the collateral even if those proceeds are not received by the debtor. See §9-102(64), cmt. 13(d). This resolves an ambiguity in the language of current §9-306(2) that suggested the security interest was limited proceeds received by the debtor. Thus, for example, if a transferee of the original collateral takes the collateral subject to the security interest under §9-315(a)(1) and subsequently sells the collateral, the security interest will attach to the proceeds of that sale under the revised act.

Expanded Definition of Proceeds

The most significant change in the proceeds rule is the expansion of the definition of proceeds. Current law generally requires a "disposition" and limits proceeds to property that replaces the original collateral. In contrast, the revised act expands the proceeds concept to include most property that is derived from the original collateral. Compare current §9-306(1) with §9-102(64).

The revised act greatly expands the types of transactions that will be treated as "dispositions" that generate proceeds. Under current law, it is unclear whether a lease or license involves a "disposition" and whether rental and license fees qualify as proceeds. While the case law suggests that such "use" payments are not proceeds,⁸ the Permanent Editorial Board takes the view that a lease does generate proceeds because it involves the disposition of a partial interest in the collateral.⁹ The revised act resolves this question by expressly including leases and licenses in the list of dispositions that generate proceeds. See §9-102(64)(A). It is not clear how extensive these revisions are. Note that the Value-Added case involved funds generated by the use of pay telephones. The Uniform Commercial Code (UCC) definition of "lease" seems broad enough to cover such a short-term use. See §§9-102(b) and 2A-103(j). If so, then this provision may extend the reach of the proceeds rule to funds generated by coin-operated devices.

Like current law, insurance payable by reason of loss or damage to the collateral is also proceeds. See §9-102(64)(E). However, the revised act expands the insurance provision to include as proceeds insurance payable by reason of nonconformity of the collateral, defects in the collateral or the infringement of rights in the collateral. Although in most cases the secured party's right to proceeds is limited only by the amount of its claim, the revised act limits the secured party's proceeds claim in insurance payments to the extent of the value of the collateral. See §9-102(64)(E).

Collections on the collateral are included as proceeds under both the current law and the revised act. See §9-102(64)(B) and current §9-306(1). However, the revised act expands the proceeds definition to also include "whatever...is distributed on account of" the collateral.¹⁰ §9-102(64)(B). Thus, both dividends payable on investment property collateral and collections or distributions on credit-support arrangements ("supporting obligations") are proceeds. See §9-102(64), cmt. 13(a) and (b). This change is designed to reject the reasoning of Hastie v. FDIC, 2 F.3d 1042, 1045 (10th Cir. 1993), which held that ordinary stock dividends were not proceeds of the stock since there was no disposition of the stock. See §9-102(64), cmt. 13(a).

The shift away from a disposition requirement is most apparent in §9-102(64)(C), which expands the definition of proceeds to include "rights arising out of collateral." Depending on how broadly the "arising out of" language is construed, this provision could greatly expand the reach of the proceeds rule. Unfortunately, the official comments do not discuss the meaning of this new provision.

Finally, the revised act extends the definition of proceeds to include various claims relating to the collateral. See §9-102(64)(D). Thus, claims for nonconformity, defects in, damage to or the loss of the collateral are proceeds.¹¹ In addition, claims for interference with the use of the collateral or for infringement of rights in the collateral are also proceeds. However, like the insurance provision, the "claims" provision limits the secured party's proceeds security interest to the extent of the value of the original collateral.

Enactment Update

With less than eight months remaining before the revised act's effective date, the outlook for uniform national adoption is bleak. There has been no new enactment activity this fall. At present, only 27 states plus the District of Columbia have adopted revised Article 9. The legislative sessions have ended in many of the remaining states where revision bills were pending, and the revision bills will need to be reintroduced when those legislatures reconvene.

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Footnotes

¹ All citations are to the revised 1999 version of Article 9 of the Uniform Commercial Code, unless otherwise indicated. Citations to the currently applicable 1972 version of Article 9 are indicated by the term "current." Return to article

² Note that the security interest, even if continued under §9-315, could be cut off by some other priority rule, such as the buyer in the ordinary course provisions of §9-320(a). Return to article

³ Although the language of the current statute is unclear, a Permanent Editorial Board comment to current §9-306(2) indicates that current law also requires that the secured party consent to a "free-and-clear" sale. See PEB Commentary No. 3, §§9-306(2) and 9-402(7) (March 10, 1990). Return to article

⁴ By including appropriate after-acquired property language in the security agreement, the security interest could attach to both proceeds and non-proceeds after-acquired property. The revised act continues the current law's broad validation of after-acquired property clauses. See §9-204(a & b). However, unlike proceeds, the secured party's right to non-proceeds after-acquired property is dependent upon the language of the security agreement. See §9-203. Return to article

⁵ If the agricultural lien does extend to proceeds, the priority analysis can be rather complex. See §9-322, cmt. 12. If the proceeds are themselves "farm products," then revised Article 9 will apply to the proceeds "agricultural lien" on those farm products. If, however, the proceeds are not farm products, then non-UCC law may govern priority. See 9-333 (limited to possessory liens). Return to article

⁶ Contra 2, Gilmore, "Security Interests in Personal Property," §27.4, at 736 (1965). Return to article

⁷ If the security interest in the original collateral was perfected, the "proceeds" security interest in the product or mass will continue to be perfected. See §§9-315(c), (d) and (e) and 9-336(d). However, special complex priority rules apply if there is a competing perfected security interest in the product or mass. See §9-336(e) and (f). Return to article

⁸ See, e.g., In re Value-Added Communications Inc., 139 F.3d 543 (5th Cir. 1998) (coins for use of pay telephones were not proceeds of the telephone because use is not a disposition). Return to article

⁹ See PEB Commentary No. 9, §9-306(1) (June 25, 1992). Return to article

¹⁰ This provision expands on the 1994 amendment to §9-306(1) that included in proceeds "payments or distributions made with respect to investment property." However, the revised act does not limit the "distribution" proceeds provision to investment property collateral. Return to article

¹¹ Some cases under current law adopt the view that claims for damage to collateral are proceeds. See, e.g., McConigle v. Combs, 968 F.2d 810, 828 (9th Cir.), cert. dismissed, 506 U.S. 948 (1992). Return to article