Security Interests in Proceeds of Collateral

This article discusses two recent bankruptcy cases that determine whether the secured party’s security interest attaches to assets acquired after the debtor files for bankruptcy as proceeds of a Federal Communications Commission (FCC) license if the security interest did not attach to the underlying FCC license. Whether an asset is after-acquired collateral or proceeds of collateral is critical to both decisions. Section 552(a) of the U.S. Bankruptcy Code (Code) limits the secured party’s lien generally to the collateral in existence on the petition date. It prevents the grant of a security interest in after-acquired property from attaching to property acquired after the bankruptcy is filed. However, section 552(b) provides that if the postpetition property is proceeds of the secured party’s prepetition collateral, then the secured party’s lien will attach to the postpetition property. This article concludes with “best practices” for drafting a security agreement as learned from these cases. But first, to fully understand these cases, we will review the meaning of “proceeds,” including identification, attachment, and perfection of a security interest in proceeds, and the anti-assignment override provisions of Article 9 of the Uniform Commercial Code (UCC).
What are Proceeds?
Section 9-102(a)(64) of the UCC provides that proceeds are whatever is received upon the sale, lease, license, exchange, or other disposition or collection of, or distribution on account of, collateral. This includes (1) claims arising out of the loss or nonconformity of, or interference with, defects in, or damage to, the collateral, (2) collections on account of “supporting obligations,” such as guarantees, (3) corporation, partnership, and limited liability company interest distributions, (4) rentals for the lease of goods, and (5) licensing royalties.
Attachment of a Security Interest
Upon the disposition or collection of collateral, a secured party’s security interest continues in any “identifiable” proceeds. If the proceeds are cash, common law principles of tracing proceeds, including the “equitable principle” of the “lowest intermediate balance rule,” are used to identify the cash proceeds. Commingled cash proceeds are identifiable within the meaning of UCC § 9-315(a)(2) as long as the balance in the bank account into which the cash proceeds are deposited does not drop below the amount of the cash proceeds initially deposited. If the balance drops below the amount that was initially deposited, the secured party may treat as identifiable proceeds only the lowest intermediate balance in the account.
Perfection of a Security Interest
If the proceeds are not identifiable cash proceeds, the perfection of the secured party’s security interest in such proceeds continues for a period of 20 days. The secured party must take steps within this 20-day period to continue the perfection of its security interest beyond such period if the proceeds constitute a collateral type that is not already perfected.
Attachment
To be prepetition property, the security interest must attach to the property. A security interest attaches to personal property upon satisfaction of three requirements: (1) the parties have an adequate security agreement, (2) the secured party gives value, and (3) the debtor has rights or the power to transfer rights in the personal property.
Generally the parties have an adequate security agreement if the debtor makes an agreement to transfer a security interest in the collateral, the collateral is reasonably described, and the debtor authenticates the security agreement. The secured party is deemed to have given value when the security interest secures an obligation. The debtor needs to have rights in the collateral and the power to transfer the rights in the collateral because the secured party can obtain only the rights that the debtor has in the collateral.
If there are contractual or legal limitations on assignment of the personal property, such limitations may not be effective due to the UCC anti-assignment override provisions. If the anti-assignment provisions are not effective, the secured party’s security interest will attach, but to protect the third-party obligor, the secured party may not enforce the security interest. The secured party benefits from the anti-assignment override even though it cannot enforce its security interest because it attaches to the collateral and, if properly perfected, the secured party will have a perfected security interest in the proceeds of a sale of the collateral that occurs after the initiation of a bankruptcy proceeding, since the proce