Daily Development for
Friday, October 16, 1998

by: Patrick A. Randolph, Jr.
Professor of Law
UMKC School of Law
Of Counsel: Blackwell Sanders Peper Martin
Kansas City, Missouri

New Developments in UCC Article 9. Treatment of Security Interests in Vendor's Interests in Installment Land Contracts

(Thanks to Dale Whitman for cluing me on to this issue - but I take the blame for the text that follows.)

A largely unnoticed change in the wording of the latest version of UCC Article 9, which has passed both NCCUSL and ALI and will be in your legislature next term, is both good new and bad news for lawyers working with clients who borrow against their vendor's interests in installment land contracts (known as "contracts for deed" in some places).

The good news is that the UCC provision, once adopted, will resolve considerable uncertainty about whether filing an assignment of the vendor's interest as an Article 9 security interest in the UCC records will adequately perfect the interest. The old answer was "maybe." After all, isn't the vendor's interest esstentially the retained title in the property that is the subject of the contract? Isn't that real estate? Doesn't one perfect a security interest in real estate by recording in the land records?

Different common law decisions in various courts held variously that UCC recording was sufficient, that recording of the assignment for security in the land records was sufficient, or that one or another or both were required depending upon the question asked. A wise lawyer would have done both in every case. But such uncertainty always gives a wise lawyer headaches all the same.

The UCC provision makes clear that the method of perfection is filing the assignment as an Article 9 security interest. Note that, unlike with mortgages, there is no negotiable instrument representing the creditor's interest that the lender can take into possession. A record filing is required, and as the debt is an "account" under new Section 9-103(a)(1), the method of record filing is determined by 9-308A(2) of the new statute.

Although 9-308A makes clear that a UCC filing is the appropriate method of perfection when some filing is required, it does not actually require filing as to all security interests in accounts. In fact, it doesn't even require perfection as to most accounts. The statute provides that a security interest in an account is automatically deemed perfected when it attaches by the assignment of the account for security.

So far, so good. No filing of any kind is required. But now comes the bad news. The statute contains an exception stating that the "automatic perfection" feature does not operate if the debtor (the installment contract vendor) has assigned to the creditor for security "a significant part of the assignor's outstanding accounts or payment intangibles." If this has occurred, then UCC filing is required.

What exactly is "a significant part of the assignor's outstanding accounts" in the context of an installment land contract vendor? Who knows. Obviously the UCC drafters were looking in another direction - attempting to deal with assignments of receivables in an ongoing business. But it is quite likely that the typical land contract vendor in most states does not deal in a great deal of "inventory" and likely only has one or two vendor's interests at any given time. Even assignment of one of them would in most cases constitute the assignment of "a significant part" of the vendor's receivables, at least unless we take into account other, unrelated receivables (and in what way or to what degree we would take these into account is anyone's guess). Thus, we continue to have ambiguity about the impact of the UCC here.

Once again, however, the good news is that as a planning matter the lesson is clear. You don't have to worry about whether the exception to 9-308A applies if you just file the security interest as a UCC security interest.

The people that will have the real problems are those transactions that "go down" without competent legal advice - often in small rural towns. Many folk in those towns will hold vendor's interests in installment land contracts as assets, and occasionally they will borrow against them. If they borrow from a bank, one would assume that the bank will be savvy enough to file in the UCC records and perhaps file in the real estate records as well. Bank counsel usually advice the "belt and suspenders" method.

But what about when some local magnate - I call them "Uncle Dud" - is the source of informal financing in the town? Uncle Dud and his lawyer probably are sophisticated enough to know that there ought to be some record of their interest. But they're dirt oriented, and probably will assume that since this is a land contract recording in the land records will be sufficient. If Uncle Dud is lucky, the assignor will have lots of other "accounts" payable to the assignor that he hasn't assigned to Uncle Dud, and the land record filing will be merely superfluous. But if the exception to 9-308A kicks in, because this is an assignment of a significant part of the borrower's "accounts," Uncle Dud won't be perfected.

The real bite of being unperfected isn't because the borrower will reassign to someone else. That happens, but not often enough to cause a lot of trouble. The problem comes in bankruptcy. If the borrower goes bankrupt, Uncle Dud's real estate filing won't be deemed a "perfection" for any purpose, and consequently the trustee in bankruptcy will be able to "strongarm" Uncle Dud right into unsecured creditor status.

Bottom line - if you're dealing with installment land contracts in your practice, brush up on the UCC filing mechanisms. You should be using them already. But failure to file an assignment of such contracts to secure an indebtedness will soon be far more likely to get both your lender client and you in a heap of trouble.

We should note that installment land contracts, though still quite prevalent in rural areas in many parts of the country, and also quite popular for other applications in states like Michigan and Iowa, are disfavored in many states. In fact, the new Restatement of Land Security proposes that the common law begin treating them as equitable mortgages. Indiana, Kentucky, Oklahoma, and several other states have legal rules to this effect already. Since installment land contract instruments aren't really designed to serve as mortgages, this creates lots of difficulty for those relying upon them. If you are in a state permitting nonjudicial foreclosure, you're probably far better off just using a deed of trust or other nonjudicial forecloseable instrument to begin with. Even in judicial foreclosure states, these devices present significant enforceability problems, and you may be better off with a mortgage to begin with, whether or not the Restatement approach takes hold.

Items in the Daily Development section generally are extracted from the Quarterly Report on Developments in Real Estate Law, published by the ABA Section on Real Property, Probate & Trust Law. Subscriptions to the Quarterly Report are available to Section members only. The cost is nominal. For the last six years, these Reports have been collated, updated, indexed and bound into an Annual Survey of Developments in Real Estate Law, volumes 1-6, published by the ABA Press. The Annual Survey volumes are available for sale to the public. For the Report or the Survey, contact Maria Tabor at the ABA. (312) 988 5590 or mtabor@staff.abanet.org

Items reported here and in the ABA publications are for general information purposes only and should not be relied upon in the course of representation or in the forming of decisions in legal matters. The same is true of all commentary provided by contributors to the DIRT list. Accuracy of data and opinions expressed are the sole responsibility of the DIRT editor and are in no sense the publication of the ABA.