The decline and fall of commercial law

A listserv post this morning accentuated a troubling trend at the intersection of commercial law and bankruptcy practice: a marked decline in confident expertise in the former.

The scenario is simple and, I suspect, common: perfected security interest in collateral (say, a car), collateral destroyed (either before or after bankruptcy filing), insurance company sends check to bankruptcy trustee rather than to the debtor or secured creditor. Trustee then claims the insurance check is not subject to the security interest, which understandably takes the secured creditor's lawyer quite by unpleasant surprise. Is this check not obviously "substitute collateral" for the destroyed original collateral (the car), s/he asks?

Well, yes, but ... neither the trustee nor a judge is likely to accept the creditor's lawyer's correct answer without some compelling analysis as to why; that is, citation to governing law (i.e., statutory authority). The challenge, which I emphasize to my Secured Transactions students every year, is that the security agreement is unlikely to resolve this. Only a lawyer who is very familiar with secured transactions law could possibly know how this answer gets worked out (regardless of what the security agreement says or does not say about insurance "proceeds"). Analysis below the fold (you know you can't resist!) ...  

The governing law here is largely outside the Bankruptcy Code, in Article 9 of the Uniform Commercial Code, which is state law, though luckily for purposes of this scenario, with identical provisions in all states (including Louisiana). The insurance check is proceeds of the original collateral (UCC § 9-102(a)(64)(E)) to which a security interest attaches automatically as a matter of law, regardless of what the security agreement says (UCC § 9-315(a)(2)), and the real kicker, so long as the interest in the original collateral was timely perfected, the replacement interest in cash proceeds is automatically and continuously perfected (UCC §§ 9-315(d)(2) and 9-102(a)(9), defining the insurance check as “cash proceeds”). The Bankruptcy Code limits "after-acquired collateral" rights, but it specifically respects this substitution of collateral for proceeds, even if it occurs post-petition (11 USC § 552(b)(1)).

The trustee in the scenario posted to the listserv either doesn’t understand Article 9 or is just testing the creditor's lawyer, it seems to me. I can tell you that many of my students fail this test, not being able to follow the chain from original collateral to proceeds, especially with respect to perfection. Even if the security agreement provides for a substitute interest in the insurance check, that interest is likely not to be perfected by any action of the creditor, who in almost every state had to perfect the interest in the car exclusively by having the lien noted on the face of the certificate of title (and Louisiana's filing regime with the Office of Motor Vehicles would lead to the same problem). An ordinary UCC-1 filing would work for the insurance check, but I doubt auto finance creditors take on this added expense and inconvenience as a matter of course. Only Article 9 itself, via the provisions cited above, not only creates, but more importantly perfects the interest in the "substitute collateral" of the insurance check.

Over seven years ago now, I lamented the bar examiners' abandonment of commercial law. At that time, bar examiners had jettisoned commercial paper (negotiable instruments) from the exam, but now, secured transactions is on the block, as well. As the new uniform bar exam format is rolled out within five or so years, commercial law will no longer be tested at all (aside from Article 2 Sales, which is just Contracts in another guise, anyway). At many (if not most) law schools, an esoteric and challenging subject's removal from the bar exam inevitably portends a sharp decline in enrollment, potentially culminating in the disappearance of the topic from the curriculum entirely. I fear this is the likely fate not only of commercial paper (which is no longer taught at many schools) but also eventually of secured transactions. New associates are likely to be increasingly unfamiliar with commercial law, especially the complex scenario described in the listserv.

And to further illustrate the fiendish complexity here, Slipster extraordinaire, Bob Lawless, quite correctly points out that the analysis above is incomplete. He writes, "Upon the wreck, there was an insurance claim. The insurance claim is proceeds of the car, and the check is proceeds of the insurance claim. The creditor was automatically perfected for 20 days in the insurance claim. If the creditor did not perfect within 20 days in the insurance claim, it became unperfected. If the check was paid within 20 days of the insurance claim arising, then I agree the creditor is perfected in the check as identifiable cash proceeds of the insurance claim. [But] the continuous perfection of UCC § 9-315(d)(1) does not apply because the insurance claim is not collateral that can be perfected in in the same office where you perfect in the car. One perfects against an insurance policy by being a loss payee or by indorsement." Touché, though I strongly suspect, based on my limited experience in such cases, that the insurance policy did name the creditor as loss payee. If not (and I doubt the claim was paid within 20 days of the destruction of the car), then Bob's super-expert analysis makes my point even more sharply--without fairly adept facility with Article 9, the right answer will not occur even to the most intelligent expert in bankruptcy law. Note to budding bankruptcy and business lawyers in general: take Secured Transactions.