Secured Transactions/UCC Article 9 (Maryland)

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Secured Transactions/UCC Article 9 (Maryland): Summary

A substantial part of any credit union’s business involves the extension of credit to its members. There are two types of loans: unsecured – that is, credit extended on the strength of the borrower’s promise, reputation, and general creditworthiness, and secured – credit extended with the backing of collateral. Collateral that can be used to secure a loan can come in many forms which are classified by UCC Article 9 and Title 9 of Maryland Commercial Law (henceforth referred to together as “Secured Transaction law”) as:

1. “Goods,” which tends to include things that can be moved (i.e. consumer goods and inventory) at the time the security interest is attached.[UCC §9-102(a)(44)]
2. “Intangible property” which is classified by characteristics rather than usage (i.e. the characteristics of an “instrument”[UCC §9-102(a)(47)] are 1. Right to payment, 2. Represented by a negotiable instrument or writing, 3. Commonly transferred by delivery and any necessary endorsement or assignment), and
3. “Fixtures” which are goods that become “fixed” to real estate when they are so related to the real estate that an interest arises in them under real estate law.[UCC §9-102(a)(41)] (With the exception of “fixtures,” Title 9 does not unilaterally govern transactions involving collateral that is considered real property).

Credit secured by property typically provides creditors access to lower interest rates and more favorable terms, but it requires a comprehensive legal framework given the nature and wide variety of personal property that can be used as collateral.

For the sake of uniformity, the Maryland’s General Assembly, like the legislatures in every other state, adopted Article 9 of the Uniform Commercial Code, codified in Maryland statute as “Maryland Uniform Commercial Code - Secured Transactions.”[MD General Assemb. HB1053. Reg Session (1999)] They remain substantially similar but there are minor differences. It is important to consult both documents when a question arises. These documents create a comprehensive legal framework designed to address the relationships between creditors, debtors and other third parties who might have an interest in a given piece of collateral.

Although secured transactions law has many narrowly defined terms, a discussion of a few key terms and concepts will be discussed to help provide a general understanding.

How does UCC Article 9 and Md. Code Ann. - Comm. Law - Title 9 affect credit unions?

Secured transactions law plays a crucial role in every credit union’s secured lending portfolio, as it serves to establish and preserve the credit union’s rights to repossess collateral upon the default of a borrower.

This body of law is divided into five main areas:

1. Effectiveness of Security Agreement; Attachment of Security Interest; Rights of Parties to Security Agreement
2. Perfection and Priority
3. Rights of Third Parties
4. Filing
5. Default

Attachment. To be enforceable, a security interest must first “attach” to the collateral. Except for rare circumstances, when a credit union does not have possession or control of the collateral, a valid security agreement can only attach once the following three steps are completed:

1. The credit union gives something of value (e.g., a loan);
2. The debtor has rights in the collateral or the power to transfer rights in the collateral; and
3. One of the following conditions is met:
   1. the debtor has authenticated a security agreement that provides a description of the collateral and, if the security interest covers timber to be cut, a description of the land concerned;
   2. the collateral is not a certificated security and is in the possession of the secured party pursuant to the debtor's security agreement (although note: possession can be by a third party that acknowledges the secured party's security interest);
   3. the collateral is a certificated security in registered form and the security certificate has been delivered to the secured party pursuant to the debtor's security agreement; or
   4. the collateral is deposit accounts, electronic chattel paper, investment property, or letter-of-credit rights (and the borrower has control over these types of rights), and the secured party has control under the UCC pursuant to the debtor's security agreement.[UCC §9-203]

A security agreement must specifically identify the collateral; for example: "2002 Honda Accord VIN 1F34567XZ34GC." Courts have often invalidated security agreements due to the lack of specificity in the description. The description must sufficiently describe the collateral, so a third party could reasonably identify the items which are subject to the security interest.

Perfection. While attachment is necessary in order to give the credit union rights against the debtor, in order to have priority against the rest of the world in a particular piece of collateral upon default of the debtor, the credit union’s security interest must be "perfected." The purpose of perfection is to give notice to the rest of the world that the secured party claims a security interest in the collateral. The superior right is created because a subsequent creditor would have been able to see that they would not have priority prior to lending and would have been expected to search records of a prior lien before lending. The manner of the perfection of a security interest depends on the type of collateral involved in the secured transaction. For example, if the property is a titled vehicle, the credit union’s lien is perfected only when the credit union’s lien is noted on the certificate of title to that vehicle. For non-titled personal property, perfection can generally be achieved by taking possession or control of the collateral (which will not always be practical), filing a financing statement, or both. When collateral is untitled property, perfection is usually achieved by taking possession or control of the collateral, filing a financing statement or both.

Once perfected, the credit union’s security interest is generally protected against the claims of subordinate creditors and transferees of the debtor, including a bankruptcy trustee.

Priorities and Third-Party Rights. Perhaps the most intricate “rules of the road” in secured transactions law that should be understood is lien priority i.e. if a debtor defaults, who has what rights and when. There are literally hundreds if not thousands of scenarios that may play out, so having at least a basic understanding of these concepts is beneficial. However, due to the complexity of the rules, if a question regarding line priority arises, it is best to ask you legal counsel for help.

Enforcement. A secured creditor has rights, both under secured transactions law and contract law, to collateral upon the default of a debtor. There very specific requirements as to how those rights can be enforced which should be understood by your credit union. Failure to properly enforce your rights after default could lead to litigation.

Enforcement under secured transactions law is generally a two-step process: First, the secured party must gain control of the collateral, typically by repossessing it. Second, the secured party must dispose of collateral, usually by selling it and converting the property into proceeds.

Following the default by a debtor, a secured party is permitted to repossess collateral without the assistance of a sheriff or other court officer (refereed to as “self-help”) as long as it does so breaching the peace. While the determination of what constitutes “breaching the peace” is a matter of facts, a general rule is that if a debtor denies repossession in any way, the creditor should avoid conflict and pursue a judicial remedy. If self-help is not available, the secured party will generally need to start an replevin action to give a court officer the authority to seize the creditor’s collateral.

After the secured party has obtained control of collateral, it must dispose of it. Secured transactions law requires multiple notices as part of this process, to include: A “Notice Before Disposition,”[UCC §9-611] and a “required notice”[Md. Code. Ann. Comm. Law §12-1021] under Maryland law.

Except in a consumer goods transaction, the notice of disposition must:

1. describe the debtor and the secured party;
2. describe the collateral that is the subject of the intended disposition;
3. state the method of intended disposition;
4. state that the debtor is entitled to an accounting of the unpaid indebtedness and states the charge, if any, for an accounting; and
5. state the time and place of a public disposition or the time after which any other disposition is to be made.[UCC §9-613(1)]

In a consumer goods transaction a notification of disposition must provide the following information:

1. All of the above required information,
2. a description of any liability for a deficiency of the person to which the notification is sent;
3. a telephone number from which the amount that must be paid to the secured party to redeem the collateral; and
4. a telephone number or mailing address from which additional information concerning the disposition and the obligation secured is available.[UCC §9-614]

The timing of a notice of disposition must be “reasonable”[UCC §9-612(a)] and a credit union should make every effort to send this notice out as soon as possible. The question of reasonableness is “a question of fact,” except in non-consumer transactions, where a 10-day period is seen as sufficient.[UCC §9-612(a-b)] The State of Maryland mandates that in some cases (vehicle repossessions) a “Required Notice” must be provided within 5 days of repossession and must hold the vehicle for 15 days.[Md. Code. Ann. Comm. Law §12-1021] Additionally, every aspect of the sale, to include prior notice to the debtor as described above, of repossessed collateral must be “commercially reasonable,” or it can later be challenged by the debtor.[UCC §9-607, UCC §9-627]

A notice of deficiency (or surplus) informs the debtor whose property has been sold following repossession the material aspects of that transaction – when it was sold; the price for which it was sold, and how the proceeds from the sale were applied (first to recover the expenses of repossession, then to late fees, interest and principal of the underlying obligation) and how much of a deficiency balance is still owed by the debtor (or surplus is due to the debtor). A notice of deficiency (or surplus) should be sent to the debtor reasonably soon after the sale and application of the proceeds. Credit Unions should ensure that their process for notifying debtors and third parties of any transactions related to a secured loan is timely.

There are severe penalties for noncompliance with secured transactions laws, ranging from limitation of the security interest to liability for damages.[UCC §9-625 and Md. Code. Ann. Comm. Law §9-625]

What actions should credit unions take to ensure compliance with Secured Transactions Laws?

Credit unions and their legal counsel should carefully consider the details of secured transactions law to ensure proper attachment and perfection of all existing and future security interests, to make sure that they understand the lien priority structure when making loans and to understand how to comply and penalties for noncompliance. Regular and ongoing review of policies and procedures, as well as regular and ongoing training of appropriate staff, is critical to ensure that a credit union’s security interest in collateral for loans is protected, and that the credit union isn’t exposing itself to liability.

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Secured Transactions/UCC Article 9 (Maryland): Laws & Regulations

• Maryland Code - Commercial Law - Title 9 – Secured Transactions
• Maryland Code - Commercial Law - Title 3 – Negotiable Instruments
• Uniform Commercial Code - Article 3 - Negotiable Instruments
• Uniform Commercial Code - Article 9 – Secured Transactions