CHAPTER 2

THE SCOPE

OF

ARTICLE 9

Article 9 of the Uniform Commercial Code sets out a comprehensive set

of rules governing secured transactions in personal property. Article 9 states
what a debtor and creditor must do to make the transaction effective (attachment or creation); what the creditor must do to give notice making the transaction effective against other parties, such as other creditors, buyers, or a
bankruptcy trustee (perfection); who wins if creditors, buyers, or other parties
contest rights in the collateral (priority); and what the creditor may and may
not do to repossess the collateral and sell it to get paid (default). This chapter deals with the issue of scope: when does Article 9 apply to a transaction?

I.

SECURITY INTEREST DEFINED

Read 1-201(b)(35) (defining security interest) and 9-109(a) (General

Scope of Article).

PROBLEM 2
Assume that a state statute gives someone doing repairs a possessory artisans lien on the property repaired. Mr. Baker took his car into Macks Garage for
repair but, being strapped for funds, couldnt pay the full bill, and Mack wouldnt
let him have the car back. Is Macks artisans lien an Article 9 security interest?
See 9-109(d)(2). If, prior to the repair work, Mr. Baker signed a statement giving

15

16

2.

The Scope of Article 9

Macks Garage a right to repossess the car if the bill wasnt paid, does this agreement create a security interest under the Code? See 9-109(a)(1).

PROBLEM 3
To raise money, Farmer Browns Fresh Vegetables Roadside Stand sold all
of its accounts receivable to Nightflyer Finance Company, which notified the
customers that henceforth all payments should be made directly to Nightflyer.
(Note that this is not a loan from the finance company to the farmer with the
accounts put up as collateral; it is an outright sale. If it were a loan, and if the
collectible accounts exceeded the amount of the loan, the excess would be
returned to Farmer Brown; in an actual sale, Nightflyer can keep the surplus. See
9-608(b).) Is this sale nonetheless an Article 9 security interest? See 9-109(a)(3).
If so, even though Farmer Brown has no further obligations to Nightflyer, he
would of necessity be termed an Article 9 debtor. See 9-102(a)(28)(B). Then
Nightflyer would have to file an Article 9 financing statement to perfect its
interest against later parties. Why would the Code drafters have brought an outright sale of accounts (and chattel paper, payment intangibles, and promissory
notes, all defined below) under the coverage of Article 9? Remember Benedict
v. Ratner? See Official Comment 4 to 9-109; Majors Furniture Mart, Inc. v.
Castle Credit Corp., 602 F.2d 538, 26 U.C.C. Rep. Serv. 1319 (3d Cir. 1979).
For the practicing attorney the possibility that a business transaction with
no apparent loan or collateral may still fall within Article 9 is a matter of great
concern. If the transaction creates an Article 9 security interest, the attorneys
client had better have taken whatever steps Article 9 requires for perfection,
or the client may lose the property to later creditors. If the attorney has not
advised the client of this possibility, the clients thoughts may turn to malpractice actions.

PROBLEM 4
The loan agreement between Dickens Publishing, Inc., and Octopus
National Bank contained a negative pledge clause. Dickens agreed not to use
any of its property as collateral for debt to other creditors. Is the transaction
governed by Article 9? Cf. Chase Manhattan Bank, N.A. v. Gems-By-Gordon,
Inc., 649 F.2d 710 (9th Cir. 1981). Suppose Dickens had agreed as follows:
Dickens agrees to repay Lender the entire principal of $18,000 on or before
April 1, 2015. If Dickens cannot refinance its current debt to cover this amount
or if another source of funds is unavailable, Dickens agrees to sell its inventory
and equipment in order to repay Lender. Is the transaction governed by Article
9? See In re Ryalls, 62 U.C.C. Rep. Serv. 2d 716 (Bankr. N.D. Cal. 2007).
A few of the obviously troublesome areas where Article 9 may or may not
apply are discussed next.

II.

II.

Consignments

17

CONSIGNMENTS

A true consignment is neither a sale nor a security device; it is a marketing procedure by which the owner of goods (the consignor) sends (consigns)
them to a retailer (the consignee) for sale to the public. The retailer does not
buy the goods (so no sale takes place when the consignor delivers the goods
to the consignee). If the retailer cannot sell them, they are returned to the
consignor. In effect, the consignee is the selling agent for the consignor,
or, looked at another way, the consignee is a bailee with the ability to sell
the bailors goods. The advantages to the consignor of a true consignment
over an outright sale (with reservation of a security interest so the goods
can be reclaimed if the retailer does not pay for them) is that the consignor
retains control over the terms of the retail sale (and thus can dictate the
retail price), and, at least at common law, there is no requirement that the
consignor file a notice anywhere announcing that a consignment is going
on. (Why, the consignors argue, should they have to notify anyone that they
have claimed an interest in their own property?) At common law, this argument tended to prevail, with the consignors able to reclaim the consigned
goods from the inventory of the consignee over the objections of the consignees other creditors; see Ludwigh v. American Woolen Co., 231 U.S. 522
(1913); In re Haley & Steele, Inc., 20 Mass. L. Rptr. 204, 2005 WL 3489869
(Mass. Super. 2005).
Nonetheless, consignments have the Benedict v. Ratner problem: The
retailer appears to be the unfettered owner of goods in inventory that actually belong to someone else (the consignor). The retailers other creditors
may wish to extend credit with the inventory as collateral, but there is no
place they can go to check whether some or all of the inventory is actually
held on consignment.
Further, some consignments are not true consignments at all but are sales
on credit (i.e., secured transactions) disguised as consignments in order to
escape the filing requirements. If the retailer must pay for the goods whether
or not able to resell them, this is not a true consignment, even if called that;
it is the creation of a security interest in goods. If a security interest is intended,
then it is not a true consignment at all; see 9-102(a)(20)(D).1 Article 9 must
be complied with (perfection by filing, etc.).
In the end, the drafters of the revised version of Article 9 decided to take
some kinds of true consignments and treat them as Article 9 matters, thus
requiring the usual steps for perfecting a security interest in someone elses
inventory (see Purchase Money Security Interests in Chapter 6) but leaving

1 This so-called consignment would typically create a purchase money security interest, requiring the steps yet to be discussed for its perfection. Because Article 9 consignments
are also given this treatment, this distinction, carefully preserved in the statute, is much ado
about nothing.

18

2.

The Scope of Article 9

some true consignments outside the Code (and thus protected by the common law rule that favored the consignor). Read 9-102(a)(20).

PROBLEM 5
Antiques R Us was the largest antiques store in the city, well known as a
place where antique dealers could hire out space and exhibit their wares, with
the store handling the sales and taking a commission on each one and returning to the dealers items that remained unsold. When the store takes out a loan
from Octopus National Bank and uses as collateral all its property, will the
banks security interest reach the items in the store that belong to the dealers if
the dealers have never taken the steps required of consignors under Article 9?
See 9-102(a)(20)(A)(iii).
The not generally known by its creditors to be substantially engaged in
selling the goods of others test from 9-102(a)(20)(A)(iii) is taken from an
identical provision in the former language of 2-326, which also exempted
such retail transactions from the necessity of compliance with the perfection
rules of Article 9. If the consignor failed to take these steps, the consignor
would frequently appeal to this factual test as a last resort but, as the case
below indicates, it was a slim reed on which to lean.
In re Fabers, Inc.
United States District Court, District of Connecticut,
Bankruptcy Division, 1972
12 U.C.C. Rep. Serv. 126

SEIDMAN, Ref. Bankr.

The bankrupt is a retail carpet and rug merchant. On May 31, 1971, the
petitioner, Mehdi Dilmaghani & Company, Inc. (dealer), shipped oriental
rugs to the bankrupt on consignment. Subsequent deliveries of rugs on a
similar basis were made on May 5, 1971, October 4, 1971, October 5, 1971,
October 7, 1971, December 6, 1971, and December 23, 1971. All of the rugs
so shipped had an identifying label attached. On each label was printed
MD. & CO., INC., Reg. No. R.N. 22956, 100% wool pile, No. _________,
Quality _________, Size _________, Sq. Feet _________, Made in Iran. The
consignment agreement provided that title to the rugs remained in the
dealer until fully paid for; that the consignee had the right to sell the rugs in
the ordinary course of business and only at a price in excess of the invoice
price; that the proceeds of any sale were the property of the dealer and held
in trust for the dealer; that the proceeds of any sale were to be remitted to
the dealer immediately with a report of the sale; [and] that all rugs were
held at the risk of the consignee.

II.

Consignments

19

No effort was made to comply with the provisions of the Uniform

Commercial Code relating to security interests. The dealer does not assert a
security interest in the rugs, claiming only that the rugs are and always were
the property of the dealer under a true consignment and, therefore, not
subject to the provisions of the Code relating to security interests. . . .
The dealers claim is that the consignment was not intended for security
and is, therefore, not subject to the requirements of Article 9. The logic of
this argument escapes the court. If the dealer did not want the agreement
to provide it with security for either the payment of the rugs or their return,
what other purpose could there have been? The agreement describes the
rugs as belonging to the dealer, but the risk of loss or damage is on the consignee. This is inconsistent with the liability of a bailee. The proceeds of the
sales were to be the property of the dealer, but the consignee is described
as holding the proceeds in trust. A trustee has title to the trust estate. The
agreement impliedly permitted the consignee to mingle the proceeds with
his own funds before remitting. At any rate, there was no requirement of a
separate account. This is inconsistent with a true trust. . . .
The principal claim of the dealer is that the transaction was a true consignment, that at all times the consignee was acting as the agent of the
dealer and, therefore, the transaction came under the exception allowed
in 2-326. . . . To protect itself from the claims of creditors, the dealer could
have complied with the filing provisions of Article 9, 2-326(3)(c), but it
admittedly did not. The only other exceptions are compliance with an applicable Connecticut law providing for a consignors interest by a sign (there
apparently is no such law) or establishing that the consignee-bankrupt was
generally known by his creditors to be substantially engaged in selling the
goods of others.
In support of the latter theory, evidence was submitted that the dealer
never dealt in oriental rugs prior to May 1971 and that an advertisement in
the local newspapers on October 12, 1971, included a picture of Mr. Mehdi
Dilmaghani together with the narrative: By Special Arrangement, we
proudly introduce: A distinctive collection of Mehdi Dilmaghani . . . renown
importer of genuine handmade Oriental, India, and Petit-Point Rugs. . . .
This hardly complies with the requirement that the bankrupt is generally
known by his creditors to be substantially engaged in selling the goods of others. (Emphasis added.) There was no evidence of any notification to any of
the bankrupts creditors to that effect. In fact, it is found that the contrary
was true. The bankrupt was not substantially engaged in selling the goods
of others.
The dealer argues that the oriental rugs were not the kind of goods in
which the bankrupt dealt. They may not have been of the same quality or
price range as the other rugs and carpets sold by the bankrupt, but they
were all of the same kind of goods to wit: floor coverings. The trade name
of the bankrupt was Fabers World of Carpets. Other than the reference
to the collection by Dilmaghani in the newspaper advertisement there was

20

2.

The Scope of Article 9

nothing to suggest any possible connection with the dealer. In fact, this
advertisement is no different from that of a department store advertising
a full line of Frigidaire appliances, or a collection of Pierre Cardins new
spring line. This is a far cry from the situation in In re Griffin, 1 U.C.C. Rep.
Serv. 492, where the bankrupt had a sign in his window advertising used
furniture and the court found that under the particular circumstances, this
was notice that goods of others were being sold. In the instant case, there
was no such notice.
There was evidence that the members of the Oriental Rug Dealers
Association usually sold their rugs on consignment. This was well known
to the members of the association. There was no evidence that this was the
universal invariable practice in the trade, or that the creditors of the bankrupt who apparently did not deal in oriental rugs knew anything about the
custom of the members of the Oriental Rug Dealers Association. As between
the parties, the transaction was a consignment agreement. As to the creditors, it was a sale or return and bound by the provisions of Section 2-326.
Since the petitioner does not come under the exceptions in this section, it
was required to comply with the filing provisions of Article 9 to preserve its
secured position. Admittedly, this was not done.
It is found that the agreement was intended for security and subject to the
requirements of 2-326. There was no perfection of the security interest and
the agreement did not come under the exceptions set forth in 2-326(3).
Accordingly, it is held that the goods are subject to the claims of creditors,
2-326(2). The reclamation petition is denied, and it is so ordered.

PROBLEM 6
When Luke Skywalker, an artisan who handcrafted his wares, finished
creating a large jeweled sword, he took it down to Weapons of the World
(WOW), a large gun and weapon dealer, which mostly sold items that it either
manufactured itself or bought from other dealers around the globe. The sword
was appraised as being worth over $25,000. Luke asked WOW to sell the
sword for him. Is this an Article 9 consignment so that Luke needs to take
Article 9 steps to protect himself from WOWs other creditors who have an
interest in the stores inventory?

III.

LEASES

A problem similar to the applicability of Article 9 to consignments occurs

when the parties disguise a secured sale as a lease.

III.

Leases

21

PROBLEM 7
BIG Machines, Inc., leased a duplicating machine to Connies Print Shop.
The lease was for five years, and the rental payments over this period exactly
equaled the current market price of the machine. The lease contract further
provided that at the end of the five years Connies Print Shop could purchase
the machine outright by paying BIG Machines $5. BIG Machines did not file an
Article 9 financing statement. Thereafter Connies Print Shop borrowed money
from the Octopus National Bank and signed a security agreement with the
bank granting it an interest in all of the print shops equipment. Octopus
National duly perfected its security interest by filing a financing statement
in the appropriate place. When Connies Print Shop failed to repay the loan,
Octopus National seized all the shops equipment, including the duplicating
machine. In the lawsuit Octopus National Bank v. BIG Machines, Inc., who
gets the machine? Read 1-201(b)(35).
Parties may wish to cast a transaction as a lease rather than a sale for many
reasons. At various times in the tortured history of tax law (a history that
is changing so fast that this writer expresses no opinion as to the current
status of the issue under the Internal Revenue Code), rental payments on
a true lease could be deducted from gross income, but in a sale the lessee
could take only depreciation on the object purchased. Tax lawyers developed much experience wrestling with the distinctions between a true lease
and a disguised sale, witness:
At the time of this writing, the use of many millions (and probably billions)
of dollars worth of equipment is being obtained through a medium of taxoriented leases where the ability of the lessor to take accelerated depreciation and obtain the Investment Tax Credit [is] so crucial that the lease will
not be entered into without a ruling by the Commissioner on this point, or
at the very least, an unqualified opinion by tax counsel, who necessarily must
err only on the side of caution. Tax counsel and administrators have developed a lore of their own for distinguishing a true lease from a disguised sale.
One point of interest is their emphasis upon the necessity for the lessors
retention of a residual of significant and measurable value. Although this element is seldom stressed as such in chattel security literature, it is suggested
that if UCC draftsmen ever deem it feasible to devise something better than
either old U.S.C.A. section 1(2) or abandoned section 7-403, study should be
directed toward the possibility of devising a formula based on the value of the
residual to be returned at the end of the lease term. A rule of thumb in tax
rulings and in super-cautious opinions of lessors tax counsel is (1) that the
lease must come to an end at a time when at least two years or twenty percent
of the useful life of the leased item remains, and (2) that this residual must
be valued at not less than 15 percent of the purchase price. The lessors tax
counsel is likely to insist that there be no options, or only an option to purchase at the market value as determined when the option is exercised. This
position is based on the premise that risk of an increase or decrease in value

22

2.

The Scope of Article 9

of the residual is an incident of the lessors ownership and that he should,

therefore, bear this risk.

P. Coogan, Leases of Equipment and Some Other Unconventional Security

Devices: An Analysis of UCC Section 1-207(37) and Article 9, 1973 Duke L.J.
909, 966-967. For other IRS tests, see Rev. Rul. 55-540, 1955-2 Cum. Bull. 39;
Rev. Proc. 75-21, 26 C.F.R. 601.201 (1975). The same issue comes up when
books must be maintained:
From an accounting point of view, the true lease has had the advantage
to the lessee of providing him with off balance sheet financing. That is to
say, the lease obligates him to pay rent and not to buy goods. Accordingly,
the leased property is not shown as an asset on the lessees balance sheet,
and, consistently, the obligation to pay rent is not listed as a liability. This
treatment tends to improve the balance sheet ratios commonly used in determining the lessees financial strength. Additionally, the obligations of a lessee under a true lease usually are not subject to restrictions on the amount
of money he may borrow contained in existing loan agreements, corporate
charters and so forth.

W. Hawkland, The Proposed Amendments to Article 9 of the UCC Part

5: Consignments and Equipment Leases, 77 Com. L.J. 108, 113 (1972). The
tax/accounting tests tend to focus on the intention of the parties and on two
other factors: (1) the equity the lessee builds in the leased property; and (2)
the value of the property surrendered to the lessor at the end of the term.
Finally, for various statutory reasons, lessors fare better in bankruptcy than
do sellers. See discussion in In re Grubbs Constr. Co., 319 B.R. 698 (Bankr.
M.D. Fla. 2005).
The drafters of the Uniform Commercial Code deal with the issue in the
complicated definition of security interest in 1-203. The drafters task was
to give some concrete guidance to the difference between a sale on credit
disguised as a lease (a security interest) and a true lease. Take a deep
breath and wade through that definition now, with the hope that the following materials will make it seem less formidable than appears at first glance.
What are we to make of this definition? As we saw in Chapter 1, where this
some issue arose, the happiest thing about it (despite its size) is that it does
draw some bright lines to help attorneys distinguish leases from secured
transactions:
1. If at the end of the lease period the lessee becomes the owner of the
property for little or no consideration, a secured transaction and not
a lease has been created.
2. If the contract contains a clause that permits the lessee to terminate
the lease at any time and return the leased goods, a true lease has
resulted. Such a right of termination is not an attribute of a sale of
goods.

III.

23

Leases

3. If the lease is for the entire economic life of the leased goods, with
or without renewal, a disguised sale has occurred. This is sometimes
called the junk pile test, because goods that are worthless at the end of
the lease are simply tossed out.
Other than that, each lease must be evaluated on its own. It does not necessarily answer the central question if the lessee pays consideration equal to
or even greater than the fair market value of the leased goods as long as the
lease does not cover the total economic life of the goods. Nor does the lessees assumption of major duties (taxes, risk of loss, etc.) necessarily indicate
a lease or a sale of goods.
Use the definition and the above tests to answer the following Problem.

PROBLEM 8
Business Corporation leased a massive copier from Copies, Inc., for a
five-year period. At the outset of the lease the copier had a fair market value
of $300,000 and a predicted ten-year useful life. Over the course of the fiveyear lease the rental payments would total to $330,000. The lease provides
that Business Corporation has the option to become the owner of the copier at
the end of the five-year period by paying Copies, Inc., the amount of $10,000.
Is this a true lease or a secured sale? Would we reach a different result if the
copiers useful life were only five years?
Gibraltar Financial Corp. v. Prestige Equipment Corp.
Supreme Court of Indiana, 2011
949 N.E.2d 314

SULLIVAN, Justice.
The parties to this lawsuit claim rights to a punch press used in the manufacturing business of now-defunct Vitco Industries, Inc. Gibraltar Financial
Corp. holds a perfected security interest in Vitcos tangible and intangible
property, including its equipment. The other parties claim that the security
interest does not cover the press because the press was not Vitcos equipment; rather, it had been leased to Vitco by Key Equipment Finance, Inc. We
find that genuine issues of material fact exist regarding whether the press
was leased.
BACKGROUND
Vitco Industries, Inc., was a manufacturer of porcelain enameled goods
in Napanee, Indiana. In April, 2004, Vitco paid $243,000 for a punch press
to use in its business. Roughly eight months later, in December, 2004, Vitco
entered into a transaction with Key Equipment Finance, Inc. (Finance),

24

2.

The Scope of Article 9

in which Finance paid Vitco the same amount, $243,000, and Finance and
Vitco executed a contract under which Vitco was entitled to use the punch
press in exchange for monthly payments. Finance and Vitco called this contract a Master Lease Agreement, which we will refer to in this opinion as
the Lease. Consistent with the lease nomenclature, Finance did not file a
financing statement in connection with the transaction.
The Lease had the following terms:

Term: Six years.

Rent: $3,591.91 per month ($43,102.92 per annum).
Net Lease Terms: Vitco was required to maintain insurance, pay all
personal property taxes, bear all risk of loss, and perform all repairs
and maintenance with regard to the press.
Early Buyout Option (EBO): Vitco was entitled to buy the press after
five years for $78,464.70 (32.29% of the total cost of the equipment),
a price that the Lease recited represented the parties[] present best
estimate of the fair market value of the Equipment on the EBO Date
determined by using commercially reasonable methods which are
standard in the industry. Appellants App. 121.
End-of-Term Options: In the event Vitco did not exercise the EBO,
Vitco was required to continue paying monthly rent during the sixth
year (total of $43,102.92). At the end of the Leases six-year term,
Vitco could do one of four things:
(1) buy the press for fair market value; or
(2) renew the Lease for the fair market renewal rental value; or
(3) continue the Lease month-to-month at the current monthly rental rate; or
(4) return the press to Finance (in which case Vitco would pay for
the presss removal and return to Finance, or Finance could attempt to sell the press directly from Vitcos facility).
For purposes of the End-of-Term Options, the Lease defined fair market
value as the Equipments value as determined between Lessor and Lessee,
based upon a price which would be obtained in an arms-length transaction
between an informed and willing lessor or seller . . . and an informed and
willing lessee or buyer. Id. at 114.
Vitco never made it to the point where it could exercise the EBO or otherwise complete the terms of the Lease. By 2007, Vitco was no longer in
business and had defaulted under the Lease.
Independent of its dealings with Finance, Vitco had entered into several
loan agreements with Gibraltar Financial Corp. pursuant to which it had
granted Gibraltar a security interest in virtually all of its tangible and intangible property, including its equipment. It is undisputed that Gibraltar perfected its security interest. In a separate lawsuit filed against Vitco in July,
2007, Gibraltar was awarded possession of the collateral in which it had a

III.

25

Leases

perfected security interest, including Vitcos equipment. Gibraltar sold that

equipment and credited Vitco with the sale proceeds, but Vitco still owed
Gibraltar almost $580,000.
In the meantime, Finance repossessed the press and sold it in July, 2007,
for $160,000 to National Machinery Exchange, Inc. (NME), in a joint venture with Prestige Equipment Corp.
In May, 2008, Gibraltar filed this action against Prestige to recover the
value of the press, alleging that Prestige had acquired the press subject to
Gibraltars security interest. A series of third-party complaints and amendments followed, as detailed in the margin. The parties agreed after a pretrial
conference that the dispute turned on whether the Lease was a true lease (as
argued by the Defendants) or a sale subject to a security interest (as argued
by Gibraltar). The trial court granted summary judgment in favor of the
Defendants after concluding that the Lease was a true lease.
The Court of Appeals affirmed the trial courts grant of summary judgment. Gibraltar Fin. Corp. v. Prestige Equip. Corp., 925 N.E.2d 751 (Ind.
Ct. App. 2010). Gibraltar sought transfer to this Court, arguing, in part,
that the decision of the Court of Appeals in this case conflicted with the
prior decision of the Court of Appeals in Gangloff Industries, Inc. v. Generic
Financing & Leasing Corp., 907 N.E.2d 1059 (Ind. Ct. App. 2009). We have
granted transfer to reconcile any conflict between these two cases and to
clarify Indiana law in distinguishing true leases from sales subject to security
interests. . . .
DISCUSSION
I
Court decisions, treatises, and articles on commercial law are replete
with declarations of the difficulty in distinguishing between true leases
and sales subject to security agreements. For example, the court in the epic
WorldCom bankruptcy case was forced to observe that though the concepts
of lease and security agreement are rather easily defined, the means to distinguish between them in a rigorous manner has often eluded the courts.
WorldCom, Inc. v. Gen. Elec. Global Asset Mgmt. Servs. (In re WorldCom,
Inc.), 339 B.R. 56, 64 (Bankr. S.D. N.Y. 2006). For their part, White and
Summers say that whether a transaction in the form of a lease is characterized
as a lease or a sale subject to a security interest is one of the most frequently
litigated issues under the Uniform Commercial Code. 4 James J. White &
Robert S. Summers, Uniform Commercial Code 17 (6th ed. 2010).
Our review of the history of these disputes suggests that much of the difficulty arose under the pre-1987 version of the Uniform Commercial Code
(U.C.C.), a uniform law adopted in some version by all 50 states. See In
re Edison Bros. Stores, Inc., 207 B.R. 801, 809 n. 7 (Bankr. D. Del. 1997)
(noting that the U.C.C. has been adopted by all 50 states). The pre-1987
U.C.C. emphasized the subjective intent of the parties entering into a lease

26

2.

The Scope of Article 9

agreement at the time the agreement was made. The Official Comment to
post-1987 U.C.C. 1-203 discusses this problem:
Reference to the intent of the parties to create a lease or security interest
led to unfortunate results. In discovering intent, courts relied upon factors
that were thought to be more consistent with sales or loans than leases. Most
of these criteria, however, were as applicable to true leases as to security interests. . . . Accordingly, [the 1987 revision of the U.C.C.] contains no reference
to the parties intent.

U.C.C. 1-203 cmt. 2 (2001) (formerly U.C.C. 1-201(37)), 1 U.L.A. 28

(2004).
The parties agree that this dispute is governed by Colorado law. Two sections of the U.C.C. as adopted by Colorado are applicable here. First, the
Colorado U.C.C. defines the term lease as follows:
Lease means a transfer of the right to possession and use of goods for
a term in return for consideration, but a sale, including a sale on approval
or a sale or return, or retention or creation of a security interest is not a
lease. . . .

Colo. Rev. Stat. 4-2.5-103(j) (2010). The key thing to note about this definition is that it specifies that a transaction creating a lease and a transaction
retaining or creating a security interest are mutually exclusive. E. Carolyn
Hochstadter Dicker & John P. Campo, FF & E and the True Lease Question:
Article 2A and Accompanying Amendments to UCC Section 1-201(37), 7
Am. Bankr. Inst. L. Rev. 517, 521 (1999).
Colorado has adopted the following provision of the U.C.C. that sets
forth rules for distinguishing a transaction creating a lease and a transaction
retaining or creating a security interest: [The court quoted 1-203.] . . .
II
Although Colorado 1-203(a) provides that [w]hether a transaction
in the form of a lease creates a lease or security interest is determined by
the facts of each case, 1-203(b) dictates that if its specifications are met,
the transaction will be deemed to have created a security interest. Thus,
Colorado 1-203(b) provides that if its bright-line test is met, the issue is
decided the transaction has created a security interest and no further
inquiry is required.
The bright-line test of 1-203(b) has two prongs which, if both satisfied,
dictate that a transaction creates a security interest. The first prong is satisfied if the consideration that the lessee is to pay the lessor for the right to
possession and use of the goods is an obligation for the term of the lease
and is not subject to termination by the lessee. Colo. Rev. Stat. 1-203(b). As
one commentator has observed, this prong is satisfied if the lease requires

III.

Leases

27

the lessee to make rental payments to the lessor come hell or high water.
Dicker & Campo, supra, at 534 (footnote omitted).
The Defendants maintain that the Lease was subject to early termination by Vitco by virtue of Vitco being able to terminate the lease by exercising the EBO. But the Court of Appeals rejected this argument, pointing
out that a termination clause differs from a buyout clause. Gibraltar, 925
N.E.2d at 755-56. We agree with the Court of Appeals and its analysis on this
point the consideration Vitco was obligated to pay was an obligation for
the term of the lease and was not subject to termination by Vitco. Thus, the
first prong of the bright-line test is satisfied.
The second prong of the bright-line test of 1-203(b) is satisfied if any
one of the four Residual Value Factors listed in 1-203(b)(1) through (4)
are found to exist. In re QDS Components, Inc., 292 B.R. 313, 332 & n. 9
(Bankr. S.D. Ohio 2002). Gibraltar acknowledges that the first three factors do not apply to the Lease. Appellants Br. 18. But it contends that the
fourth factor does, arguing that the Lease provided Vitco with an option
to become the owner of the goods for no additional consideration or for
nominal additional consideration upon compliance with the [Lease]. Colo.
Rev. Stat. 4-1-203(b)(4). If so, both prongs of the bright-line test would be
satisfied and the transaction would have created a security interest.
As discussed under Background, supra, the Lease gave Vitco two opportunities to become the owner of the punch press at the end of the Lease
and upon exercise of the EBO.
At the end of the Lease, Vitco had the right to purchase the press for its
fair market value; no specific amount was provided. Did this provision give
Vitco the right to buy the press for no additional consideration or for nominal additional consideration?
The statute provides that [a]dditional consideration is not nominal if:
. . . the price is stated to be the fair market value of the goods determined at
the time the option is to be performed. 322 Colo. Rev. Stat. 4-1-203(d)(2).
The price stated for Vitco to purchase the press at the end of the lease was
its fair market value, in so many words, and so the consideration in this
circumstance was not nominal. As such, the provisions of the end-of-term
option did not cause the transaction to create a security interest.
The provisions of the EBO, however, were quite different. Under the EBO,
Vitco had the right to buy the press after five years for the specific amount of
$78,464.70. And as described in Background, supra, the Lease did declare
that the parties agreed that this amount represented their best estimate of
what the fair market value of the equipment would be on the EBO date. The
Defendants argue that this language had the effect of stat[ing] that Vitco
could purchase for fair market value within the meaning 1-203(d)(2). For
the same reason the provisions of the end-of-term option did not cause the
transaction to create a security interest, the Defendants contend, so too for
the EBO.

28

2.

The Scope of Article 9

The Court of Appeals rejected this contention, holding that the EBO
applie[d] a fixed price [(the $78,000 amount)] to the value of the Punch
Press rather than permitting the price to be determined at the time the
option [was] to be performed. Gibraltar, 925 N.E.2d at 757. The Court of
Appeals was correct in concluding that for 1-203(d)(2) to operate, the fair
market value of the goods must be determined at the time the option is to
be performed. But, at the same time, 1-203(e) directs that reasonably
predictable . . . fair market value . . . shall be determined with reference
to the facts and circumstances at the time the transaction is entered into.
Even if we were to conclude, reading these two provisions together, that fair
market value could be specified in advance under the Fair Market Value
Test, we think that for the Defendants to be entitled to summary judgment
on this point, they were required to set forth material facts demonstrating
that the $78,000 price constituted the expectations of Vitco and Finance at
the time the transaction was entered into as to what the fair market value of
the punch press would be on the EBO date.
Except for the recitation in the contract itself, there was no evidence presented to the trial court of the expectations of Vitco and Finance at the
time the transaction was entered into as to what the fair market value of the
punch press would be on the EBO date. There was evidence presented by
Gibraltars expert that the value of the press near the time of the EBO date
was at least $100,000. Appellants App. 229. And there was evidence that after
Vitcos default, Finance sold the press for $160,000 approximately two-anda-half years after the Lease was executed. Id. at 110. While these facts are not
relevant to establishing the expectations of Vitco and Finance at the time
the transaction was entered into, they are enough to keep us from crediting
the contract recitation alone as reflecting the parties actual expectations.
We agree with the Court of Appeals that Finance failed to establish that the
$78,000 EBO price is not nominal under the Fair Market Value Test.
While the Court of Appeals did not find 1-203(d)(2) applicable here,
it came to the ultimate conclusion that Vitco did not have an option to
become the owner of the punch press for only nominal additional consideration upon compliance with the EBO. It reached this result by applying the
test embodied in the first sentence of 1-203(d) referred to in the cases
as the Option Price/Performance Cost Test and concluding that the
$78,000 price was greater than Vitcos reasonably predictable cost of performing if the EBO was not exercised. Gibraltar, 925 N.E.2d at 756-57 (citing
In re QDS Components, 292 B.R. at 335). We agree. Had Vitco declined to
exercise the EBO, it would have been required to pay an additional approximately $43,000 in rent. The only evidence in the record indicates that the
cost to return the punch press would have equaled approximately $19,500,
although that figure was not estimated at the time the parties entered into
the agreement. Appellants App. 228. In any event, the $78,000 price is not
less than even the sum of these two amounts and, therefore, not nominal
within the meaning of 1-203(d). Gibraltar, 925 N.E.2d at 757; see also In

III.

29

Leases

re QDS Components, 292 B.R. at 335-340 (detailing the proper method of

applying the Option Price/Performance Cost Test of 1-203(d)).
To review, we have applied the objective, bright-line test of 1-203(b)
and concluded that the Lease did not create a security interest per se. Even
though it was not subject to termination by Vitco, compliance with the
Lease required Vitco to pay more than nominal consideration to become
the owner of the press. This is because the $78,000 EBO price was not less
than Vitcos reasonably predictable cost of performance under the Lease
had the EBO not been exercised within the meaning of the Option Price/
Performance Cost Test of 1-203(d).
III
A

Under the objective, bright-line test of 1-203(b), the Lease did not create
a security interest per se. But because 1-203(a) provides [w]hether a transaction . . . creates a lease or security interest is determined by the facts of
each case, the facts of this case may nevertheless dictate that the Lease did
create a security interest. In re WorldCom, 339 B.R. at 70; Sankey v. ABCO
Leasing, Inc. (In re Sankey), 307 B.R. 674, 680 (Bankr. D. Alaska 2004) (citing In re QDS Components, 292 B.R. at 333).
If a court finds that a transaction did not create a security interest per se,
it must then consider the economic reality of the transaction in order to
determine . . . whether the transaction is more fairly characterized as a lease
or a secured financing arrangement. Duke Energy Royal, LLC v. Pillowtex
Corp. (In re Pillowtex), 349 F.3d 711, 719 (3d Cir. 2003). Unfortunately, the
U.C.C. does not provide any explicit test or methodology for assessing the
economic reality of the transaction. As a result, the cases contain a plethora
of formulations and approaches which we will briefly survey.
The majority of courts and commentators recite that the principal inquiry
in this regard is whether the lessor has retained a meaningful reversionary
interest in the goods. In re WorldCom, 339 B.R. at 71 (emphasis in original)
(citation omitted). However, again, the U.C.C. does not provide for assessing
whether a lessor has retained a meaningful reversionary interest. In re QDS
Components, 292 B.R. at 341. Nevertheless, the WorldCom court explained
the rationale for the meaningful reversionary interest test as follows:
If the lessor does not possess a meaningful reversionary interest, the lessor
has no interest in the economic value or remaining useful life of the goods,
and therefore the lessor transferred title to the goods, in substance if not in
form. In other words, the parties did not create a lease where the putative lessor does not have the interest, the entrepreneurial stake, in the goods that a
true lessor would have.

339 B.R. at 72. But as the WorldCom court itself acknowledged, this reasoning by itself is circular. Id. In point of fact, the absence of any accepted

30

2.

The Scope of Article 9

method of determining whether a meaningful reversionary interest exists

renders such a determination more a statement of conclusion that the
transaction is a lease than a method of analysis.
For its part, the Court of Appeals recognized that the cases provide
no consistent set of factors for identifying a lessors residual interest.
Gibraltar, 925 N.E.2d at 758 (quoting In re Gateway Ethanol, L.L.C., 415 B.R.
486, 504 (Bankr. D. Kan. 2009)). Following the Gateway court, it decline[d]
to apply a laundry list of factors identified by other courts [and instead
focused] on the economic factors of the Lease.2
In sorting through these various formulations, we first conclude that
the U.C.C. has rejected the laundry list approach in an apparent effort to
overrule a series of bad decisions under the pre-1987 version of section
1-201(37). 4 White & Summers, supra, at 30. This was done because many
of the factors considered under the old approach were just as applicable to
true leases as they were to security interests. Kimco Leasing, 656 N.E.2d at
1218 n.15; In re QDS Components, 292 B.R. at 326.
Nonetheless, the U.C.C. does not explicitly prohibit consideration of
these factors. Rather, it provides that [a] transaction in the form of a lease
does not create a security interest merely because of the presence of any
one or more of the six factors. Colo. Rev. Stat. 1-203(c)(1)-(6) (emphasis
added). Indeed, the Court of Appeals in Gangloff Industries, Inc. v. Generic
Financing & Leasing, Corp. relied on this language in concluding that certain factors were not prohibited from consideration. 907 N.E.2d at 1066 n.8;
see also In re WorldCom, 339 B.R. at 71 (noting that the factors are characterized as not sufficient alone to establish that a security interest has been
created. . . . Leading scholars, on the other hand, have opined that with
the exception of the first,3 the conditions are not only not enough, but
are simply not relevant in distinguishing between true leases and security
interests. 4 White & Summers, supra, at 33.

2. Similar to the Court of Appeals in this case, the Indiana Tax Court has rejected the
laundry list approach and instead identified two considerations in determining whether
the lessor retained a meaningful residual interest: 1) whether the lease contains an option
to purchase for no or nominal consideration, and 2) whether the lessee develops equity in
the leased property such that the only sensible decision economically for the lessee is to
exercise the purchase option. Kimco Leasing, Inc. v. State Bd. of Tax Commrs, 656 N.E.2d
1208, 1218 & n.15 (Ind. Tax Ct. 1995); see also In re QDS Components, 292 B.R. at 342-43
(noting that California law considers similar factors). We note that the first consideration
duplicates the second prong of the bright-line test contained in 1-203(b)(4). See In re QDS
Components, 292 B.R. at 343 n.20 (noting the redundancy in considering the nominality of
the option price a second time in the meaningful-residual-interest analysis).
3. The first condition considers the amount of rent the lessee is required to pay as compared to the fair market value of the goods at the time the lease is entered into. Colo. Rev.
Stat. 1-203(c)(1). We agree with these scholars that the exclusion of the first condition is
puzzling because [n]ormally one would assume that when [the first condition] is met the
parties have a secured sale, not a lease. 4 White & Summers, supra, at 30-31.

III.

31

Leases
B

To be entitled to summary judgment, the Defendants bear the burden

of demonstrating the absence of any genuine issue of material fact as to
whether the economic realities of the transaction dictate that it is a lease
as a matter of law. Ind. Trial Rule 56(C). The Court of Appeals concluded
that the Defendants were entitled to summary judgment because Finance
had retained a meaningful reversionary interest in the punch press. This
was so, according to the Court of Appeals, primarily because the equipment would still have had significant value had Vitco decided to return it
at the end of the six-year Lease. It reached this conclusion because the useful life of the punch press was apparently fifteen to twenty years. Gibraltar,
925 N.E.2d at 758.
The putative lessor in the Pillowtex case made a similar argument. In that
case, the Third Circuit found
that under certain circumstances, the fact that transferred goods have a
useful life extending beyond the term of the transferring agreement could
reveal the transferors expectation of retaining residual value in those goods.
Such an inference would only be proper, however, where the evidence showed
a plausible intent by the transferor to repossess the goods.

In re Pillowtex, 349 F.3d at 720. In Pillowtex, the court found no likelihood

that the transferor would repossess the fixtures in question because their
removal would have been prohibitively expensive. Id. at 720-21. That is certainly not the situation with the punch press. But Pillowtexs analysis does
lead us to conclude that the punch presss useful life extending beyond the
term of the Lease does not by itself establish that the transaction was a true
lease.
C

In the end, we focus on economics. U.C.C. 1-203 cmt. 2 (2001), 1

U.L.A. 29 (2004). This includes all the economic factors which drove the
transaction and which were the prime impetus to the ultimate decision to
enter into the transaction and the reasons for structuring the transaction
as it was done. Am. President Lines, Ltd. v. Lykes Bros. Steamship Co., Inc.
(In re Lykes Bros. Steamship Co., Inc.), 196 B.R. 574, 580 (Bankr. M.D. Fla.
1996); see, e.g., United Airlines, Inc. v. HSBC Bank USA, N.A., 416 F.3d 609,
617 (7th Cir. 2005) (finding as determinative the measure for rent, the presence of a balloon payment, the effect of prepayment, and the lessee already
having the asset and using it for an extension of credit); Kentuckiana Med.
Ctr. LLC v. The Leasing Group Pool II, LLC (In re Kentuckiana Med. Ctr.
LLC), No. 10-93039-BHL-11, 2011 Bankr. LEXIS 1702, 2011 WL 1750769, at
*7 (Bankr. S.D. Ind. May 6, 2011) (noting that the leases were structured in
such a way as to make lessees cost of returning the collateral exceed the cost
of purchasing it); In re Grubbs Constr. Co., 319 B.R. 698, 720 (Bankr. M.D.

32

2.

The Scope of Article 9

Fla. 2005) (noting the key factor for entering into the transaction was the
effective interest rate charged for financing); Gangloff Indus., 907 N.E.2d at
1065 (citing evidence that consideration was based on the price plus interest divided by months). Other factors may include, but are not limited to,
the total amount of rent required of the lessee, whether the lessee acquired
equity or any pecuniary interest in the goods, the useful life of the goods,
the practical limitations on the lessees ability to remove and return the
leased goods, and the ability of the lessor to market the equipment. In re
Uni Imaging Holdings, LLC, 423 B.R. 406, 418-20 (Bankr. N.D. N.Y. 2010)
(citing In re Gateway Ethanol, 415 B.R. at 505); In re WorldCom, 339 B.R. at
74; In re Grubbs Constr. Co., 319 B.R. at 718-721.
At least some of these factors are present in this case. Pointing toward the
transaction creating a security interest is the fact that Vitco already owned
the punch press when it entered into the Lease with Finance (and it may
have used it as security for an extension of credit). Pointing toward the transaction creating a lease are the useful life of the punch press, the absence of
limitations on its removal, and the ability of Finance to market it.
What we are not able to determine, however, is whether the payment provisions of the Lease are more indicative of a lease or of a secured financing
arrangement. We know that the purchase price of the press at the time of
the transaction was $243,000. We know that Vitco had the option of purchasing it after five years for a total outlay of roughly $294,000 (60 monthly
payments of $3,591.91 plus the EBO price of $78,464.70). And we know that
if Vitco had not exercised the EBO, it would have been required to make
twelve additional monthly payments totaling $43,102.92 (a total outlay of
roughly $259,000), and thereafter it could have purchased the punch press
for its then-appraised value.
The economics of the transaction can certainly be cast to demonstrate
a lease: The parties agreed that Vitco would lease the punch press for 72
months at $3,592 per month with an option to buy at fair market value at
the end. Under this approach, the EBO is an aside an agreement as to the
option price if Vitco wanted to exercise the option after 60 months.
On the other hand, the economics could also be cast to demonstrate a
sale subject to a security interest: Vitco agreed to buy the punch press for
$294,000 with 60 monthly payments of $3,592 plus a balloon payment of
$78,000. Under this approach, the language regarding the sixth year was
mere surplusage paying the $78,000 was the only economically sensible
course for Vitco to take.
A bankruptcy case discussed by both sides in their briefs illustrates this
point. In that case, a construction company had entered into several equipment leases. In re Grubbs Constr. Co., 319 B.R. 698. Under the leases
early buyout options, the price was determined in advance and in no way
depended on a future valuation. Id. at 720-21. In holding that the equipment leases had created security interests, the court found that the only

33

IV. Other Transactions

economically sensible course for [the company], absent default, was to exercise the Early Buyout Option and acquire the equipment. Id. at 721.
As the movants for summary judgment, the Defendants had the burden
of establishing the absence of any genuine issue of material fact as to the
economic realities of the transaction dictating that it was a lease as a matter
of law. To do so required evidence of the expectations of Vitco and Finance
at the time the transaction was entered into as to such factors as the value of
the punch press on the EBO and lease expiration dates, the discount rate,
and whether the only economically sensible course for Vitco would have
been to exercise the EBO. We regret having to remand this case for further
proceedings, but the authorities are clear that [f]oresight not hindsight
controls. 4 White & Summers, supra, at 33; see also In re Uni Imaging
Holdings, 423 B.R. at 417 (In determining whether additional consideration is nominal, the Court is to examine the economic realities of the
transaction and the expectations of the parties concerning the projected
value of the equipment at the time they entered into the agreement. . . .
(citing In re Gateway Ethanol, 415 B.R. at 500)). We see no way of resolving
this case without this evidence. Because such evidence was not presented,
summary judgment was not appropriate.
CONCLUSION
For the foregoing reasons, the judgment of the trial court is reversed and
the case is remanded for proceedings consistent with this opinion.
In close cases the advising attorney may wish to tell the lessor (or the
alleged consignor in quasi-consignment problems) to play it safe and file a
financing statement even if it is believed that a true lease/non-consignment
has been created. This may create a danger, however, that the Article 9 filing
is an admission (for tax/accounting purposes) that only a secured transaction is involved. To avoid this admission problem, the drafters gave us
9-505, which you should read.

IV.

OTHER TRANSACTIONS

PROBLEM 9
When Mercy Hospitals administrators decided to build a new addition,
they hired a general contractor named Crash Construction Co. and required
it to get a surety to guaranty the performance of the construction job and
the payment of all the workers and material suppliers (to avoid a mechanics
lien on the hospital). Standard Surety issued such a performance and payment
bond covering Crashs obligation to Mercy Hospital. To finance the construction, Crash borrowed money from Octopus National Bank (ONB) and gave

34

2.

The Scope of Article 9

as collateral the right to collect the progress payments from Mercy Hospital
as they came due. ONB duly filed an Article 9 financing statement. Halfway
through the job, Crash went bankrupt, and Standard Surety had to finish and
pay off the employees and suppliers. At this point, by virtue of the common
law right to subrogation (the equitable right given to sureties to step into the
legal shoes of persons they have paid), Standard Surety claimed a superior right
to unpaid monies retained by Mercy Hospital, which were to be paid to Crash.
ONB also claimed this fund, pointed to its filed security interest, and stated
that Standard Suretys subrogation right was only an unfiled Article 9 security interest. Who should win? See New Mexico State Highway and Transp.
Dept. v. Gulf Ins. Co., 996 P.2d 424, 40 U.C.C. Rep. Serv. 2d 863 (N.M. App.
1999); Comment, Equitable Subrogation Too Hardy a Plant to Be Uprooted
by Article 9 of the UCC? 1971 U. Pitt. L. Rev. 580.

V.

EXCLUSIONS FROM ARTICLE 9

Read 9-109(c) and (d).

A.

Federal Statutes

It is no surprise that the Uniform Commercial Code, a state statute, cannot displace federal law. From the way 9-109(c)(1) is worded, however,
note that the UCC does apply to the extent that the federal statute does
not answer the problem presented. See G. Gilmore, Security Interests in
Personal Property, ch. 13 (1965) (hereinafter G. Gilmore); for a list of such
statutes, see J. White & R. Summers, Uniform Commercial Code 22-11 (6th
ed. 2010)(hereinafter White & Summers). With the exception of the federal
tax lien statute, Internal Revenue Code 6321-6325, most federal statutes
(for example, the Ship Mortgage Act of 1920 and the Civil Aeronautics Acts
provisions on security interests in aircraft) do not cover the field and are
constantly supplemented by Article 9 provisions in litigation.
In United States v. Kimbell Foods, 440 U.S. 715, 26 U.C.C. Rep. Serv. 1
(1979), the Supreme Court decided that, as a matter of federal law, the relative
priority of private consensual liens arising in favor of the U.S. government
under various lending programs is to be decided under non-discriminatory
state law (i.e., the UCC), unless a federal statute clearly provides otherwise.
For the practitioner, the important thing to remember is that certain
matters must be researched on a federal as well as a state level. Ship mortgages, aircraft titles, railroad equipment, and some interstate commercial
vehicles (such as trucks and buses registered with the Interstate Commerce
Commission) are, in part, governed by federal statutes. Creditors (and

V.

Exclusions from Article 9

35

their attorneys) who simply think an Article 9 filing will perfect their interest in, say, an airplane, end up as unsecured creditors whose only cause
of action may be against their state-law-minded attorneys. See Feldman
v. Chase Manhattan Bank, N.A., 368 F. Supp. 1327, 13 U.C.C. Rep. Serv.
1333 (S.D.N.Y. 1974) (assignment of airplane lease with Article 9 filing not
effective against bankruptcy trustee where creditor failed to file with FAA
as required by Federal Aviation Act). Exciting efforts are under way to create an international registration system for rail, planes, and satellites, and
some parts of the plan are already in place; see www.unidroit.org/english/
conventions/c-main.htm.
Further, certain federal statutes may void some security interests. Section
125 of the Truth in Lending Act, 15 U.S.C. 1635 (1980), for instance,
destroys any security interest taken in a consumers home as part of a credit
transaction if the credit seller does not notify the consumer of a three-day
right to rescind the contract (and supply the consumer with other Truth-InLending disclosures).
Some federal statutes may be more friendly to creditors than Article 9.
Magnacom Wireless bought FCC radio spectrum licenses on credit, but was
unable to pay the price when due. The FCC revoked the licenses and resold
them, for $249 million more than Magnacom owed. Had Article 9 applied,
Magnacom would have been entitled to the surplus. But under the governing
federal law, the FCC was entitled to keep the surplus. See In re Magnacom
Wireless, LLC, 503 F.3d 984, 63 U.C.C. Rep. Serv. 2d 985 (9th Cir. 2007).
NOTE ON INTELLECTUAL PROPERTY AS COLLATERAL
Strangely enough, there is great confusion as to whether security interests
in various types of intellectual property are to be perfected under federal or
state law. The federal trademark, patent, and copyright statutes all provide
that security interests may be recorded in the relevant federal office (the
U.S. Patent and Trademark Office or the Copyright Office). But none of
the three statutes are clear on whether federal filing is required to perfect
the security interest. Courts have reached a variety of conclusions on the
issues. See In re Together Dev. Corp., 37 U.C.C. Rep. Serv. 2d 227 (Bankr. D.
Mass. 1998) (trademarks should be filed under Article 9); In re Cybernetic
Services, Inc., 252 F.3d 1039, 44 U.C.C. Rep. Serv. 2d 639 (9th Cir. 2001) (patents should be filed under Article 9); Rhone-Poulenc Argo, S.A. v. DeKalb
Genetics Corp., 284 F.3d 1323 (Fed. Cir. 2002) (stating that federal filing
would govern priority in patent rights); In re World Auxiliary Power Co.,
303 F.3d 1120, 48 U.C.C. Rep. Serv. 2d 447 (9th Cir. 2002) (security interest
in unregistered copyrights should be filed under Article 9); In re Peregrine
Entertainment, Ltd., 116 B.R. 194 (C.D. Cal. 1990) (security interest in registered copyrights should be filed in Copyright Office).
The matter is of some real practical importance. If a UCC filing is all
that is required, one filing in the name of the debtor will do it for all the

36

2.

The Scope of Article 9

intangible rights he/she owns; if a federal filing is necessary, it will have to

be done for each patent, copyright, or trademark, a much more expensive
undertaking. Cf. White & Summers 22-11.

PROBLEM 10
Pollution Solutions, Inc., took out a loan from Octopus National Bank
(ONB), putting up as collateral its copyright, patents, and trademarks. Where
should ONB file to be sure it has a perfected security interest? No one knows
where ONB must file to perfect its security interest, but the question here is
slightly different.
Philko Aviation, Inc. v. Shacket
United States Supreme Court, 1983
462 U.S. 406

Justice WHITE delivered the opinion of the Court.

This case presents the question whether the Federal Aviation Act of 1958
(Act), 49 U.S.C. 1301 et seq., prohibits all transfers of title to aircraft from
having validity against innocent third parties unless the transfer has been
evidenced by a written instrument, and the instrument has been recorded
with the Federal Aviation Administration (FAA). We conclude that the Act
does have such effect.
On April 19, 1978, at an airport in Illinois, a corporation operated by
Roger Smith sold a new airplane to respondents. Respondents, the Shackets,
paid the sale price in full and took possession of the aircraft, and they have
been in possession ever since. Smith, however, did not give respondents the
original bills of sale reflecting the chain of title to the plane. He instead gave
them only photocopies and his assurance that he would take care of the
paperwork, which the Shackets understood to include the recordation of
the original bills of sale with the FAA. Insofar as the present record reveals,
the Shackets never attempted to record their title with the FAA.
Unfortunately for all, Smith did not keep his word but instead commenced a fraudulent scheme. Shortly after the sale to the Shackets, Smith
purported to sell the same airplane to petitioner, Philko Aviation. According
to Philko, Smith said that the plane was in Michigan having electronic equipment installed. Nevertheless, Philko and its financing bank were satisfied
that all was in order, for they had examined the original bills of sale and
had checked the aircrafts title against FAA records. At closing, Smith gave
Philko the title documents, but, of course, he did not and could not have
given Philko possession of the aircraft. Philkos bank subsequently recorded
the title documents with the FAA.

V.

Exclusions from Article 9

37

After the fraud became apparent, the Shackets filed the present declaratory judgment action to determine title to the plane. Philko argued that it
had title because the Shackets had never recorded their interest in the airplane with the FAA. Philko relied on 503(c) of the Act, 49 U.S.C. 1403(c),
which provides that no conveyance or instrument affecting the title to any
civil aircraft shall be valid against third parties not having actual notice of the
sale, until such conveyance or other instrument is filed for recordation with
the FAA. However, the District Court awarded summary judgment in favor
of the Shackets, 497 F. Supp. 1262 (N.D. Ill. 1980), and the Court of Appeals
affirmed, reasoning that 503(c) did not preempt substantive state law
regarding title transfers, and that, under the Illinois Uniform Commercial
Code, Ill. Rev. Stat., ch. 26, 1-101 et seq., the Shackets had title but Philko
did not. 681 F.2d 506 (CA7 1982). We granted certiorari, ____ U.S.____
(1982), and we now reverse and remand for further proceedings.
Section 503(a)(1) of the Act, 49 U.S.C. 1403(a)(1), directs the Secretary
of Transportation to establish and maintain a system for the recording of
any conveyance which affects the title to, or any interest in, any civil aircraft
of the United States. Section 503(c), 49 U.S.C. 1403(c), states:
No conveyance or instrument the recording of which is provided for by
[503(a)(1)] shall be valid in respect of such aircraft . . . against any person
other than the person by whom the conveyance or other instrument is made
or given, his heir or devisee, or any person having actual notice thereof, until
such conveyance or other instrument is filed for recordation in the office of
the Secretary of Transportation.

The statutory definition of conveyance defines the term as a bill of sale,

contract of conditional sale, mortgage, assignment of mortgage, or other
instrument affecting title to, or interest in, property. 49 U.S.C. 1301(20)
(Supp. V, 1981). If 503(c) were to be interpreted literally in accordance
with the statutory definition, that section would not require every transfer
to be documented and recorded, it would only invalidate unrecorded title
instruments, rather than unrecorded title transfers. Under this interpretation,
a claimant might be able to prevail against an innocent third party by establishing his title without relying on an instrument. In the present case, for
example, the Shackets could not prove their title on the basis of an unrecorded bill of sale or other writing purporting to evidence a transfer of title
to them, even if state law did not require recordation of such instruments,
but they might still prevail, since Illinois law does not require written evidence of a sale with respect to goods for which payment has been made
and accepted or which have been received and accepted. Ill. Rev. Stat., ch.
26, 2-201(3)(c).
We are convinced, however, that Congress did not intend 503(c) to be interpreted in this manner. Rather, 503(c) means that every aircraft transfer must

38

2.

The Scope of Article 9

be evidenced by an instrument, and every such instrument must be recorded,

before the rights of innocent third parties can be affected. Furthermore,
because of these federal requirements, state laws permitting undocumented
or unrecorded transfers are preempted, for there is a direct conflict between
503(c) and such state laws, and the federal law must prevail.
These conclusions are dictated by the legislative history. The Senate,
House, and Conference committee reports, and the section-by-section analysis of one of the bills drafters, all expressly declare that the federal statute
requires the recordation of every transfer of any interest in a civil aircraft. The Senate report explains: This section requires the recordation
with the Authority of every transfer made after the effective date of the section, of any interest in a civil aircraft of the United States. The conveyance
evidencing each such transfer is to be recorded with an index in a recording
system to be established by the Authority. Thus, since Congress intended to
require the recordation of a conveyance evidencing each transfer of an interest in aircraft, Congress must have intended to preempt any state law under
which a transfer without a recordable conveyance would be valid against
innocent transferees or lienholders who have recorded.
Any other construction would defeat the primary congressional purpose
for the enactment of 503(c), which was to create a central clearing house
for recordation of titles so that a person, wherever he may be, will know
where he can find ready access to the claims against, or liens, or other legal
interests in an aircraft. Hearings before the House Comm. on Interstate
and Foreign Commerce, 75 Cong., 3d Sess., 407 (April 1, 1938) (testimony
of F. Fagg, Director of Air Commerce, Dept. of Commerce). Here, state law
does not require any documentation whatsoever for a valid transfer of an
aircraft to be effected. An oral sale is fully valid against third parties once the
buyer takes possession of the plane. If the state law allowing this result were
not preempted by 503(c), then any buyer in possession would have absolutely no need or incentive to record his title with the FAA, and he could
refuse to do so with impunity, and thereby prevent the central clearing
house from providing ready access to information about his claim. This is
not what Congress intended.
In the absence of the statutory definition of conveyance, our reading
of 503(c) would be by far the most natural one, because the term conveyance is first defined in the dictionary as the action of conveying, i.e.,
the act by which title to property . . . is transferred. Websters Third New
International Dictionary 499 (P. Gove ed. 1976). Had Congress defined
conveyance in accordance with this definition, then 503(c) plainly would
have required the recordation of every transfer. Congress failure to adopt
this definition is not dispositive, however, since the statutory definition is
expressly not applicable if the context otherwise requires. 49 U.S.C. 1301.
Even in the absence of such a caveat, we need not read the statutory definition mechanically into 503(c), since to do so would render the recording system ineffective and thus would defeat the purpose of the legislation.

V.

Exclusions from Article 9

39

A statutory definition should not be applied in such a manner. Lawson v.

Suwannee S.S. Co., 336 U.S. 198, 201 (1949). Accordingly, we hold that state
laws allowing undocumented or unrecorded transfers of interests in aircraft
to affect innocent third parties are preempted by the federal Act.
In support of the judgment below, respondents rely on Matter of Gary
Aircraft Corp., 681 F.2d 365 (CA5 1982), which rejected the contention that
503 preempted all state laws dealing with priority of interests in aircraft.
The Court of Appeals held that the first person to record his interest with
the FAA is not assured of priority, which is determined by reference to state
law. We are inclined to agree with this rationale, but it does not help the
Shackets. Although state law determines priorities, all interests must be federally recorded before they can obtain whatever priority to which they are
entitled under state law. As one commentator has explained, The only situation in which priority appears to be determined by operation of the [federal] statute is where the security holder has failed to record his interest.
Such failure invalidates the conveyance as to innocent third persons. But
recordation itself merely validates, it does not grant priority. Scott, Liens in
Aircraft: Priorities, 25 J. Air L. & Com. 193, 203 (1958). Accord, Sigman, The
Wild Blue Yonder: Interests in Aircraft Under Our Federal System, 46 So.
Cal. L. Rev. 316, 324-325 (1973) (although recordation does not establish
priority, failure to record . . . serves to subordinate); Note, 26 Wash. & Lee
L. Rev. 205, 212-213 (1979).
In view of the foregoing, we find that the courts below erred by granting the
Shackets summary judgment on the basis that if an unrecorded transfer of an
aircraft is valid under state law, it has validity as against innocent third parties.
Of course, it is undisputed that the sale to the Shackets was valid and binding as between the parties. Hence, if Philko had actual notice of the transfer
to the Shackets or if, under state law, Philko failed to acquire or perfect the
interest that it purports to assert for reasons wholly unrelated to the sale to
the Shackets, Philko would not have an enforceable interest, and the Shackets
would retain possession of the aircraft. Furthermore, we do not think that the
federal law imposes a standard with which it is impossible to comply. There
may be situations in which the transferee has used reasonable diligence to file
and cannot be faulted for the failure of the crucial documents to be of record.
But because of the manner in which this case was disposed of on summary
judgment, matters such as these were not considered, and these issues remain
open on remand. The judgment of the Court of Appeals is reversed, and the
case is remanded for further proceedings consistent with this opinion.
So ordered.
NOTE
For the resolution of this case on retrial, see Shacket v. Philko Aviation, Inc.,
841 F.2d 166, 5 U.C.C. Rep. Serv. 2d 727 (7th Cir. 1988) (second purchaser,
alas, still lost because of failure to investigate suspicious circumstances).

40

2.

B.

The Scope of Article 9

Landlords Lien and Other Statutory Liens

Subsections (d)(1) and (2) of 9-109 exclude statutory liens (like the one
in Problem 276) from Article 9; but what about the following situation?

PROBLEM 11
When Christopher Morley opened his bookshop, the landlord wanted
security for the rent. They signed a lease agreement providing that all of the
inventory (the books) would be subject to a lien in the landlords favor and
could be seized and sold if Christopher defaulted in the rent payments. Is the
landlords lien required to be perfected under Article 9? See Persky, Shapiro,
Salim, Esper, Arnoff & Nolfi Co., L.P.A. v. Guyuron, 2000 WL 1867407, 43
U.C.C. Rep. Serv. 2d 1009 (Ohio App. 2000).

C.

Wage Assignments

Claims to wages were once a fertile source of collateral, but special statutory regulation has all but killed off wage assignments. Thus, some states
absolutely prohibit the assignment of future wages (see, e.g., Ala. Code tit.
39, 201; such assignments are void); some permit them in limited circumstances if the employer consents (see, e.g., Del. Code Ann. tit. 5, 2115;
N.C. Gen. Stat. 95-31); and some states require the consent of both the
employer and the spouse (see, e.g., Ind. Code 22-2-7). Employers always
disliked having to bother with direct payments to an employees creditors
(and further disliked the idea that employees had little or no equity left in
their own paychecks). The special statutes on the matter survive the enactment of Article 9; 9-109(d)(3).

PROBLEM 12
Carl Jugular was an independent insurance agent who sold policies for
many companies, though his primary sales were the life and automobile policies of the Montana Insurance Association (MIA). In order to float a loan to buy
a car, Carl gave the lending bank a security interest in all present and future
commissions earned or to be earned from the MIA. Does Article 9 cover this
assignment? See Massachusetts Mut. Life Ins. Co. v. Central Pa. Natl. Bank, 372
F. Supp. 1027, 14 U.C.C. Rep. Serv. 212 (E.D. Pa. 1974).

D.

Non-Financing Assignments

The 9-109(d)(4) through (7) exclusions of some transfers of accounts,

chattel paper, payment intangibles, and promissory notes is meant to be an

V.

Exclusions from Article 9

41

exclusion of all such assignments of a non-financing nature. See G. Gilmore

10-5. Generally, as we have seen, such sales would be Article 9 matters, but
in the listed situations no one would think to comply with Article 9, and the
possibility of the deception of later parties is small.

PROBLEM 13
When David Vargo sold his lucrative art business to Manny Flowers, he
sold not only all the tangible assets but his outstanding accounts receivables
as well. Must the buyer take the steps required by Article 9 of a secured party?
See 9-102(a)(72)(D) and 9-109(d)(4). If Vargo received a commission to paint
the portrait of the citys mayor but decided he was too busy to perform the
task and (with the mayors permission) transferred the job (and the right to the
payment for it) to another artist, must the new artist take Article 9 steps? See
9-109(d)(6). When one of Vargos clients refused to pay for a delivered painting, Vargo sold the account to Trash Collection Agency. Must Trash comply
with Article 9? See 9-109(d)(5). Finally, pressed by his art supplies store for
payment of his outstanding tab, Vargo transferred to the store the money due
him from a client whose portrait he had painted the month before. Must the
art supplies store take Article 9 steps? See 9-109(d)(7).

E.

Real Estate

Except for fixtures, real estate security interests are not covered by Article
9, but what happens when the paperwork creating them (the mortgage and
the promissory note the debtor signs) is used as security when the mortgagee seeks a loan?

PROBLEM 14
Local Loan Company (LLC) needed to borrow money, and Octopus
National Bank (ONB) agreed to loan it the requisite amount, taking into ONBs
possession as collateral the real property mortgages and accompanying promissory notes given to LLC by its borrowers. Need ONB do anything either in
the real property recording office or under the UCCs Article 9 to protect its
interest in this collateral? Compare 9-109(d)(11) and 9-109(b); read Official
Comment 7 to 9-109; see the helpful discussion in R. Bowmar, Real Estate
Interests as Security Under the UCC: The Scope of Article Nine, 12 UCC L.J.
99 (1979); and see 9-203(g) and 9-308(e). See Prime Fin. Servs. LLC v. Vinton,
279 Mich. App. 245, 260 (Mich. Ct. App. 2008).

42

2.

F.

The Scope of Article 9

Other Exclusions

PROBLEM 15
Octopus National Bank issued Connie Consumer a credit card. As collateral for the credit card debts, ONB took a security interest in all items she
purchased using the card, as well as in her personal checking account with the
bank. Does Article 9 apply to the banks rights in this account? See 9-109(d)(13).
Would Article 9 apply if she used her consumer bank account as collateral for
a business loan? See 9-102(a)(26).

PROBLEM 16
Debtors assigned to Octopus National Bank all sums recovered by
Debtors, directly or indirectly, from their lawsuit against Meep Corporation for
breach of a sales contract. Meep Corporation settled the lawsuit, and agreed
to pay Debtors the claimed amount. Is the assignment subject to Article 9? See
9-109(d)(9). See Goldberg & Connolly v. New York Cmty. Bancorp, Inc., 565
F.3d 66, 65 U.C.C. Rep. Serv. 2d 867 (2d Cir. 2009).
Section 9-109(d) lists some other items that are excluded from Article 9
coverage in whole or in part (insurance, certain tort claims, etc.). We will
consider these matters as they arise in other contexts.