84-9-306. (a) Governing law: Issuer's or nominated person's jurisdiction. Subject to subsection (c), the local law of the issuer's jurisdiction or a nominated person's jurisdiction governs perfection, the effect of perfection or nonperfection, and the priority of a security interest in a letter-of-credit right if the issuer's jurisdiction or nominated person's jurisdiction is a state.
(b) Issuer's or nominated person's jurisdiction. For purposes of this part, an issuer's jurisdiction or nominated person's jurisdiction is the jurisdiction whose law governs the liability of the issuer or nominated person with respect to the letter-of-credit right as provided in K.S.A. 84-5-116, and amendments thereto.
(c) When section not applicable. This section does not apply to a security interest that is perfected only under K.S.A. 2023 Supp. 84-9-308(d), and amendments thereto.
History: L. 2000, ch. 142, § 26; L. 2002, ch. 159, § 10; May 23.
KANSAS COMMENT, 1996
Subsection (1). This subsection, which does not vary from the 1995 Official Text, defines the term "proceeds." The term is extremely broad. As an example, assume that a bank is financing an appliance dealer. The proceeds generated from the sale of new inventory could include a great variety of proceeds: accounts receivable, instruments, chattel paper, cash, trade-ins, and bank deposit accounts, to name the most obvious. In this list, the cash, checks, credit card drafts and deposit accounts would qualify as "cash proceeds." The accounts receivable, notes, chattel paper and trade-ins would qualify as "noncash proceeds." The distinction between cash proceeds and noncash proceeds becomes important in determining priorities under subsections (3) and (4). The 1972 amendments qualified an insurance payout as "proceeds," even in the absence of a loss payee clause; earlier decisions were in conflict on that issue. Any payments made with respect to investment property is proceeds, as a result of the 1994 amendment of the Official Text. Proceeds also includes proceeds of proceeds, and proceeds claims can be made to collateral even after many exchanges, if the transactions can be traced. Thus a secured party with a security interest in inventory can claim the new inventory acquired with cash proceeds of old inventory as proceeds of proceeds, in addition to any claim from an after acquired property clause. See C.O. Funk and Sons, Inc. v. Sullivan Equipment, Inc. 431 N.E.2d 370 (Ill. 1982)
Subsection (2). Subsection (2), which does not vary from the 1995 Official Text, provides that a security interest continues in collateral, allowing secured parties to claim both the collateral and the proceeds on sale or other disposition, with two exceptions discussed below. Although this may seem like a windfall, the difficulty of tracing either the proceeds or the collateral often means the secured part is at a substantial risk after an unauthorized sale by an often insolvent debtor. The secured party now has an automatic right to proceeds on the disposition of collateral. Nor do proceeds need to be mentioned in the security agreement. 84-9-203(3).
The phrase "Except where this article otherwise provides" is the first exception to a secured party's right to claim the collateral after disposition. The exceptions are contained in the 84-9-300's which detail when a mere secured party is subordinate to third party interests in the collateral, primarily 84-9-301, and when even perfected secured parties are subordinate to third party interests, the most common of which are most of the provisions from 84-9-307 to 84-9-319.
The second exception to the secured party's continued right to the collateral after disposition is if the disposition is authorized by the secured party in the security agreement "or otherwise." The leading Kansas case on point of "or otherwise" is North Central Kansas Production Credit Association v. Washington Sales Co., 223 K. 689, 577 P.2d 35 (1978), which was an action for conversion brought by an Article 9 secured party against a livestock auction firm which had sold encumbered cattle at the direction of the debtor and had paid over the proceeds to the debtor. The secured party sought to recover from the auction company under 84-9-307(1), which provides that persons buying farm products cannot take free as buyers in ordinary course of business; and under this subsection, which provides that a security interest continues in collateral notwithstanding disposition, unless the secured party authorized the disposition. (Since 1986, however, the secured party would have had to comply with the terms of the Food Security Act of 1985, 7 U.S.C. § 1631, discussed in the Kansas Comment 1996 to 84-9-307(1).) The court concluded that the secured party's acceptance of proceeds from the debtor after unauthorized sales, without remonstrating with the debtor for violating the anti-sale provision of the security agreement, did not of itself constitute an implied waiver of the security interest in the cattle. The court did find an express waiver, however, because the PCA loan officer had orally told the debtor that he could sell the cattle so long as he applied the proceeds to the loan. In short, there was no conversion because the secured party had given authorization for sale, not in the security agreement, but "otherwise." The court also rejected the concept of "conditional authorization." On the other hand, if there is no evidence of express consent to sale, the mere acceptance of proceeds from prior sales is presumably not enough to release the security interest in Kansas.
It should be emphasized that, absent authorization to sell, a perfected security interest will continue in both the collateral and any "identifiable proceeds." For example, if a bank has taken a perfected security interest in a farm implement which the debtor without authority trades in to the implement dealer for a new model, and if the implement dealer (or its sales finance company) finances the purchase of the new unit, the bank has several options: (1) it can pursue the old unit under this subsection, by way of replevin or conversion; and (2) it can claim a security interest in the new unit as "proceeds" from disposition of the old, and, (3) if its security agreement contains an after-acquired property clause, it can claim the new model as after-acquired property. Although its security interest may well be subordinate to the implement dealer's purchase money security interest under 84-9-312(4) as to the amount in excess of the value of the trade-in, any equity would go to the bank until its debt was satisfied.
Cash proceeds generated from the sale of inventory or the collection of accounts, and then deposited in a bank account, are also "identifiable cash proceeds" in which the security interest will remain perfected under 84-9-306(3). If the collections are segregated into a special proceeds account, there is no doubt that the perfected status will carry over. Moreover, Kansas and many other jurisdictions hold that the proceeds remain "identifiable" even though they are commingled with other funds in the bank account. See Bank of Kansas v. Hutchinson Health Services, Inc., 12 K.A.2D 87, 735 P.2D 256 (1987). In Tuloka Affiliates, Inc. v. Security State Bank, 229 K. 544, 627 P.2d 816 (1981), the court recognized a bank account as identifiable cash proceeds of an inventory loan, but gave priority to the bank's right to receive payments in the ordinary course of the debtor's business. See 84-9-306 Official Comment 2.(c). Cases in other jurisdictions include C.O. Funk and Sons, Inc. v. Sullivan Equipment, Inc. 431 N.E.2d 370 (Ill. 1982)(court held the secured party could trace proceeds into account and use the lowest intermediate balance rule, but the secured party failed to carry the factual burden of tracing its funds into the account); Michigan Nat'l Bank v. Flowers Mobile Home Sales, Inc., 217 S.E.2d 108 (N.C. App. 1975) (court applies trust principles to allow the commingled proceeds to retain their identifiability); Universal C.I.T. Corp. v. Farmers Bank of Portageville, 358 F. Supp. 317 (E.D. Mo. 1973) (court invokes "lowest intermediate balance rule" for tracing); Brown & Williamson Tobacco Corp. v. First Nat'l Bank, 504 F.2d 998 (7th Cir. 1974) (secured party allowed to trace commingled proceeds).
Subsection (3). This subsection does not vary from the 1995 Official Text. Subsection (3) addresses the problem of whether a perfected secured interest in the collateral is automatically perfected in the proceeds. It does not have any application in cases involving insolvency proceedings, which are addressed in 84-9-306(4). 84-9-306 (3) provides that in most, but not all, cases the security interest in proceeds is automatically continuously perfected, and subsequent creditors, secured parties and other purchasers, such as buyers, will be subject to the perfected security interest in the proceeds. Therefore, third parties should be extremely cautious when dealing with a debtor who is subject to a perfected security interest.
If the secured party had a perfected security interest in the collateral, the security interest in the proceeds is also perfected for ten days, in all cases. 84-9-306(3)(d). It is also continuously perfected automatically if the conditions in 84-9-306(3)(a) through (c) are met, as discussed below.
First, under 84-9-306(3)(a), in the first part of the paragraph, a claim to proceeds will be continuously perfected if the perfected secured party has filed a financing statement covering the original collateral and the proceeds are collateral which could be perfected by a filing in the same office. To illustrate, assume the debtor is in the business of selling inventory and the perfected secured party has filed for inventory with the secretary of state. If the debtor sells inventory on open credit, the proceeds is an account, the security interest in which could be perfected by filing in the secretary of state's office. Therefore the perfected secured party has a continuous perfected security interest in the account. The same would be true if the proceeds were chattel paper (a note and a security interest), trade-ins (used inventory), or property that would be used by the debtor as equipment. All could be perfected by a filing in the secretary of state's office, therefore all are continuously perfected. There would be no automatic perfection for instruments because filing is not effective. Cash proceeds are discussed in 84-9-306(3)(b) and (c), discussed below.
The last part of paragraph 84-9-306(3)(a) provides for a more restrictive rule for proceeds acquired with cash proceeds. In that case, the security interest in the proceeds is continuously perfected only if the filed financing statement for the original collateral indicates the type of property which are the proceeds. Thus, in the hypothetical above, if the debtor received cash proceeds and used them to buy more inventory, the secured party would have a perfected proceeds claim to the new inventory, assuming it could adequately trace them. (This would be in addition to its claim under an after-acquired property clause, if it had one in the security agreement.) Because the vast majority of business filings in Kansas are in the secretary of state's office (see 84-9-401), the security interest in proceeds will usually be continuously perfected.
84-9-306(3)(b) and (c) provide that a security interest is automatically continuously perfected in identifiable cash proceeds. This would include commingled bank accounts, using the lowest intermediate balance rule to trace them. See Bank of Kansas v. Hutchinson Health Services, Inc., 12 K.A.2d 87, 735 P.2d 256 (1987). 84-9-306(1) includes "money, checks, deposit accounts and the like" in the definition of cash proceeds.
84-9-306(3)(d) provides the secured party a continuously perfected security interest in any case in which it is not automatically perfected by the above provisions, if it perfects within the ten day period. The major common application for this provision in the hypothetical given above will be equipment acquired with cash proceeds (defined in 84-9-306(1)). It would be extremely rare for other types of collateral, such as general intangibles, investment property or consumer goods, to be proceeds.
Subsection 4. The 1995 Official Text, sets forth special rules governing the right to proceeds in case of the debtor's insolvency (normally, bankruptcy). A perfected security interest in proceeds will be upheld in all identifiable noncash proceeds (e.g., chattel paper, accounts receivable, trade-ins), and in separate deposit accounts where the proceeds are not commingled with other funds. It will also be upheld in currency and checks which have neither been commingled with other cash nor deposited in a bank account. But if cash proceeds have been commingled with other funds of the debtor, the security interest is subject to any right of setoff if the bank has a superior right of setoff, and it generally is limited to the amount of proceeds received by the debtor within ten days prior to the insolvency proceedings. For a good application of this last rule, see In re Dexter Buick-GMC Truck Co., 28 U.C.C. Rep. 243 (D.R.I. (Bankr.) 1980), where the secured creditor was able to trace proceeds from the sale of motor vehicle inventory into the corporate checking account by using cash receipt journals, invoices, and bank deposit statements. Since the amount of proceeds deposited within ten days prior to bankruptcy far exceeded what was in the account on the date of the petition, the creditor could claim the entire account as identifiable cash proceeds under subsection (4)(d). For decisions involving the ten-day rule as it relates to voidable preferences in bankruptcy, compare In re Gibson Products of Arizona, 543 F.2d 652 (9th Cir. 1976) with Fitzpatrick v. Philco Fin. Corp., 491 F.2d 1288 (7th Cir. 1974). The preferable reading of 84-9-306(4)(d) would be that it creates a fund from which a specific perfected secured party's claim can be satisfied. The fund is any account in which the secured party's proceeds were commingled at any time. The specific secured party's claim is the amount of any proceeds from that particular secured party's collateral within ten days prior to the insolvency proceeding (and less any cash proceeds received under (4)(a), (b) and (c).
Subsection (5). This subsection, which does not vary from the 1995 Official Text, sets forth rules governing returned or repossessed goods. Subsection (5)(a) reinforces 84-9-205 by providing that the original security interest continues in returned goods. For a good application of this subsection, see In re Frontier Mobile Home Sales, Inc., 635 F.2d 726 (8th Cir. 1980). Subsection (5)(b) provides that an unpaid transferee of chattel paper who gave new value and took possession of the chattel paper has a security interest in the goods with priority over the security interest asserted under subsection (5)(a). Subsection (5)(c) allows an unpaid transferee of an account to have a security interest, but it is subordinate to the security interest in the goods provided for in subsection (5)(a). Subsection (5)(d) requires the unpaid transferee under subsections (5)(b) and (5)(c) to perfect its security interest to be protected against creditors of the transferor and purchasers of the returned or repossessed goods.
Revisor's Note:
Former section 84-9-306 was repealed by L. 2000, ch. 142, § 155 and the number reassigned to the current text.
Law Review and Bar Journal References:
"Proceeds" discussed in article concerning "floor plan financing," Charles H. Oldfather, 14 K.L.R. 571, 573, 578, 580, 585 (1966).
Inclusion of "proceeds" as collateral in farm financing and continuity thereof discussed, Van Smith, 35 J.B.A.K. 300, 302 (1966).
Secured transactions under the U.C.C., Gerald D. Haag, 21 K.L.R. 107 (1972).
"The New UCC Article 9 Amendments," Barkley Clark, 44 J.B.A.K. 131, 171 (1975).
"Changes in Article Nine of the Kansas Commercial Code," Alan Tipton, 15 W.L.J. 212, 218, 224, 225, 228 (1976).
Survey of contracts, UCCC and UCC, Franklin E. Lynch and Larry Schneider, 15 W.L.J. 324, 334, 335 (1976).
U.C.C. section discussed in note concerning a secured party's claim in excess of identifiable proceeds in bankruptcy proceeding, 16 W.L.J. 738, 739, 741, 742, 743, 744 (1977).
"Survey of Kansas Law: Secured Transactions," J. Eugene Balloun, 27 K.L.R. 301, 307 (1979).
"Right of Secured Party to Recover Proceeds Commingled in Debtor's Bank Account," Kristen D. Balloun, 28 K.L.R. 325 (1980).
"Commercial Law—Problems with Identifiable Proceeds and Transfers in Ordinary Course in Floor Plan Financing," Richard L. Cram, 30 K.L.R. 478, 480, 482 (1982).
"Survey of Kansas Law: Secured Transactions," J. Eugene Balloun, 32 K.L.R. 351, 359, 365 (1984).
"Agricultural Credit and The Uniform Commercial Code: A Need for Change?" Keith G. Meyer, 34 K.L.R. 469, 479, 483, 485 (1986).
"Clear Title: A Buyer's Bonus, A Lender's Loss—Repeal of UCC § 9-307(1) Farm Products Exception by Food Security Act § 1324 [7 U.S.C. § 1631]," Mark V. Bodine, 26 W.L.J. 71, 73, 75 (1986).
"Commercial Law: Identifiable Proceeds and the Knowledge Factor [Farmers State Bank v. Production Credit Association, 243 Kan. 87, 755 P.2d 518 (1988)]," Mahesh I. Patel, 28 W.L.J. 295, 305 (1988).
"Revised Article 9 in Kansas," Hon. John K. Pearson, 51 K.L.R. 769, 809 (2003).
CASE ANNOTATIONS
1. Mentioned; application of proceeds of collateral to secured debts. State Bank of Downs v. Moss, 203 Kan. 447, 457, 454 P.2d 554.
2. Mentioned in discussion of commercial security interest priority over federal tax liens; circumstances necessary for priority. Donald v. Madison Industries, Inc., 483 F.2d 837, 844.
3. Interest of judgment creditor held inferior to holder of perfected security interest even though secured party failed to file financing statement within ten days of sale. Blair Milling & Elevator Co., Inc. v. Wehrkamp, 217 Kan. 122, 123, 124, 125, 126, 535 P.2d 457.
4. Section mentioned; purpose discussed; conviction under 21-3734 upheld. State v. Ferguson, 221 Kan. 103, 107, 558 P.2d 1092.
5. Applied; under facts there was no conversion where collateral sold at direction of the debtor who received proceeds; consent. North Cent. Kan. Prod. Cred. Ass'n v. Washington Sales Co., 223 Kan. 689, 692, 577 P.2d 35.
6. Although funds debited by bank were identifiable proceeds from sale of collateral, creditor cannot recover same. Tuloka Affiliates, Inc. v. Security State Bank, 229 Kan. 544, 546, 550, 553, 554, 556, 627 P.2d 816.
7. Considered in action by creditor under floor plan arrangement to recover moneys debited from checking account. Tuloka Affiliates, Inc. v. Security State Bank, 229 Kan. 544, 546, 553, 627 P.2d 816 (1981).
8. Credit company's perfected purchase money security interest in cars has priority over bank's security interest; cars not sold to a buyer in ordinary course of business. First National Bank and Trust Co. v. Ford Motor Credit Co., 231 Kan. 431, 437, 646 P.2d 1057 (1982).
9. Collateral "proceeds" are whatever is substituted for original collateral. In Re SMS, Inc., 15 B.R. 496, 499, 500 (1981).
10. Trustee had priority over consignor with perfected security interest in proceeds when cash commingled with other cash proceeds. In re Critiques, Inc., 29 B.R. 941, 942, 944, 945, 946 (1983).
11. Security agreement effective between parties and against purchasers of collateral; security interest continues unless disposition authorized by secured party. Clark Jewelers v. Satterthwaite, 8 Kan. App. 2d 569, 571, 662 P.2d 1301 (1983).
12. Cited in holding assignment of rights in contract not transfer of deposit account. First Nat'l Bank of Gaylord v. Autrey, 9 Kan. App. 2d 96, 97, 673 P.2d 448 (1984).
13. Bank, as secured creditor, had right to proceeds of grain sales by debtor. Iola State Bank v. Bolan, 235 Kan. 175, 183, 679 P.2d 720 (1984).
14. Farm creditor's oral consent at outset of loan, permitting sales conditioned on remitting proceeds, constitutes consent waiving security interest. Peoples Nat'l Bank & Trust v. Excel Corp., 236 Kan. 687, 689, 695, 695 P.2d 444 (1985).
15. Sale of livestock without prior consultation with bank; auction company liable for conversion. First Nat'l Bank & Tr. Co. v. Atchison County Auction Co., 10 Kan. App. 2d 382, 387, 699 P.2d 1032 (1985).
16. Cited; entrustment doctrine (84-2-403(2)) examined and applied. Executive Financial Services, Inc. v. Pagel, 238 Kan. 809, 815, 715 P.2d 381 (1986).
17. Cited provisions dealing with secured party's interest in proceeds prevailing over default provisions after debtor files bankruptcy examined. Maxl Sales Co. v. Critiques, Inc., 796 F.2d 1293, 1296, 1297, 62 B.R. [168] [169] (1986).
18. Creditor's security interest in engagement ring set taken by codebtor without debtor's permission did not constitute secured claim. In re Elliott, 64 B.R. 429, 431 (1986).
19. Identifiable proceeds construed; perfected security interest in proceeds has priority over bank's right of setoff. Bank of Kansas v. Hutchinson Health Services, Inc., 12 Kan. App. 2d 87, 91, 92, 93, 94, 735 P.2d 256 (1987).
20. Cited; constitutionality of statute on debtor depriving creditor of creditor's own money (21-3734(1)(c)) examined. State v. Jones, 242 Kan. 385, 389, 748 P.2d 839 (1988).
21. Cited; liability of third-party tortfeasor's insurer to party holding security interest in vehicle after insurer settles with owner-operator examined. Scholfield Bros., Inc. v. State Farm Mut. Auto. Ins. Co., 242 Kan. 848, 855, 752 P.2d 661 (1988).
22. In absence of authorization to sell, transferee of proceeds takes subject to security interest of secured party. Farmers State Bank v. Production Cred. Ass'n of St. Cloud, 243 Kan. 87, 98, 755 P.2d 518 (1988).
23. Auction house agent liable for conversion where owner lacked authority to sell, notwithstanding lack of knowledge of security interest. First Nat. Bank v. Southwestern Livestock, Inc., 859 F.2d 847, 849 (10th Cir. 1988).
24. Secured creditor expressly authorized transfer of collateral from partnership to chapter 11 debtor; security interest therein waived. E-4 Excavating, Inc. v. Lawrence Nat. Bank & Trust, 101 B.R. 269 (1989).
25. Cash in possession of debtor's bankruptcy trustee from sale of "Payment in Kind" certificates covered by financing statement entitling secured creditor to proceeds. In Re George, 119 B.R. 800, 804 (1990).
26. Absent authorization, borrower and seller of excavator could not modify lender's perfected security interest. U.S. v. Ables, 739 F. Supp. 1439, 1446 (1990).