We are pleased to welcome attorney, Bennett L. Cohen of Cohen, Salk and Huvard, P.C., as a special guest blogger. Please read on for the fourth installment of Bennett’s seven-part blog series on Purchase Money Security Interest in Equipment and Inventory.

The Official Comment to Section 9-324 contains the following examples which demonstrate the application of the priority rules as they affect proceeds of inventory constituting accounts:

“9. Priority in Accounts Constituting Proceeds of Inventory.   The application of the priority rules in subsection (b) is shown by the following examples:

Example 1:   Debtor creates a security interest in its existing and after-acquired inventory in favor of SP-1, who files a financing statement covering inventory.  SP-2 subsequently takes a purchase-money security interest in certain inventory and, under subsection (b), achieves priority in this inventory over SP-1.  This inventory is then sold, producing accounts.  Accounts are not cash proceeds, and so the special purchase-money priority in the inventory does not control the priority in the accounts. Rather, the first-to-file-or-perfect rule of Section 9-322(a)(1) applies.  The time of SP-1’s filing as to the inventory is also the time of filing as to the accounts under Section 9-322(b).  Assuming that each security interest in the accounts proceeds remains perfected under Section 9-315, SP-1 has priority as to the accounts.

Example 2:  In Example 1, if SP-2 had filed directly against accounts, the date of that filing as to accounts would be compared with the date of SP-1’s filing as to the inventory.  The first filed would prevail under Section 9-322(a)(1).

Example 3:  If SP-3 had filed against accounts in Example 1 before either SP-1 or SP-2 filed against inventory, SP-3’s filing against accounts would have priority over the filings of SP-1 and SP-2.  This result obtains even though the filings against inventory are effective to continue the perfected status of SP-1’s and SP-2’s security interest in the accounts beyond the 20-day period of automatic perfection.  See Section 9-315.  SP-1’s and SP-2’s position as to the inventory does not give them a claim to accounts (as proceeds of the inventory) which is senior to someone who has filed earlier against accounts.  If, on the other hand, either SP-1’s or SP-2’s filing against the inventory preceded SP-3’s filing against accounts, SP-1 or SP-2 would outrank SP-3 as to the accounts.”

The foregoing examples demonstrate (a) the important concept that a purchase-money priority in inventory does not carry over into proceeds of such inventory constituting accounts, and (b) the basic principle that in evaluating priority in accounts generally, the first to file against accounts or inventory will have priority in the accounts.   

Official Comment 8 to Revised Section 9-324 explains in part the rationale behind not giving the purchase-money inventory lender a priority in accounts constituting proceeds of inventory: 

“Many parties financing inventory are quite content to protect their first-priority security interest in the inventory itself.  They realize that when the inventory is sold, someone else will be financing the resulting receivables (accounts or chattel paper), and the priority for inventory will not run forward to the receivables constituting the proceeds.  Indeed, the cash supplied by the receivables financier often will be used to pay the inventory financing.  In some situations, the party financing the inventory on a purchase-money basis makes contractual arrangements that the proceeds of receivables financing by another be devoted to paying off the inventory security interest.”

Blanket lien lenders negotiating inter-creditor agreements with purchase-money lenders must be careful not to sign an inter-creditor agreement which may give the purchase-money lender a priority in the proceeds of the inventory constituting accounts. Be sure to check back next week when Bennett L. Cohen discusses thee examples of Priority Rules!

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