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Help Me Decide -- Is a "Replacement" New Collateral

posted by Bob Lawless

This semester, I have been teaching secured credit from Lynn LoPucki and Elizabeth Warren's wonderful textbook. One of the problems from the book was, I believe, inspired by my former colleague at UNLV and current bankruptcy judge, Bruce Markell, who requires his students to draft a security agreement taking a security interest in an object he brought to class. A student's agreement has presented an interpretive issue with the problem, and I told him I would get the input of our readership on Credit Slips. One thing the assignment allowed me to do is to talk about boilerplate. There is nothing necessarily wrong with boilerplate, but we should understand what it is doing when we use it.

The object I brought to class was a baseball signed by the great Lou Brock, a Hall of Fame outfielder for the St. Louis Cardinals. The instructions specifically state that the students are to draft a security agreement taking a security interest in this object--the baseball--and nothing else. If the students comply with the instructions, they get a pass on the assignment, and if not, they get a fail. As Markell always said to me--in the real world there is no such thing as a security agreement that is almost valid.

The student's security agreement took a security interest in all “Property described in this agreement” and defined "property" as the baseball and "all parts, accessories, repairs, replacements, improvements, and accessions to the property; any original evidence of title or ownership; and all obligations that support the payment or performance of the Property." The student has persuaded me that most of this clause does not raise any practical possibility that he would get a security interest in something other than the baseball. For example, what would be an "accession" to the baseball? I'm willing to buy that, but the word "replacements" bothers me. Suppose I lose this baseball and buy a new baseball signed by Lou Brock. That would arguably be a "replacement" and thereby extra collateral that violates the instructions of the assignment.

Does my student get a "pass" on this assignment?

Comments

Please correct me if I'm wrong, but the replacement would only be necessary if the collateral was lost, destroyed, or otherwise removed from your possession (and no longer securing the agreement).

If this agreement is meant to be non-recourse, then I guess the loss goes to the counterparty. If the counterparty DOES have recourse, however, it seems to me that the security interest should attach to the replacement if the original was lost, destroyed, or otherwise removed from your possession.

How does that sound?

I guess I would fail the question rather than the answer.

The purpose of a security device is to assure payment of some debt.

If the question is so strict as to preclude a security interest in an identical replacement, then the creditor is clearly at risk to debtor misbehavior.

Also, I can't tell from the question whether it was an entire agreement or just the granting clause. Proceeds are omitted and, while not fatal to the grant, it is better practice to mention them in the grant.

Finally, if the risk of an F is to reflect the fact that an almost valid security interest is invalid, the fact that the grant exceeds the scope of the question does not render the grant invalid and so by that standard an F is not appropriate.

Replacement could be and in most security instruments is Insurance which is the Replacement or indemnification. Obviously its irreplaceable but insurance could be and will probably be required in any security agreement if the item does not remain in the lenders possession. If it was kept in say a joint lock box or in the possession of the lender the lender would probably still want that type of language and may still take out a policy.

"Replacement" smacks of Insurance lingo from what I remember from my Insurance Adjuster classes.

All of that and I may still be just shooting off the hip. Pass or fail?

Thank you for all of these comments. On Mr. Loeb's and on Patches's point, I don't think the security interest could automatically be traced to the replacement unless we could trace the proceeds of the collateral into the replacement. We need a contractual commitment for that, and that is the function this security agreement serves, which is I am pondering whether it constitutes extra property.

MT makes a very good point about failing the question. The point of limiting the property in which the security interest is taken is (a) to make the students give an adequate description of the collateral and (b) to impose some limits on what the creditor can do so as to mimic whatever bargaining leverage the debtor might have. I agree completely that what I don't like about applying the instruction so literally to this case is that it penalizes what is a better real-world security agreement.

I say give it a pass. Recall that, under your hypothetical scenario, the security interest in the original baseball would automatically attach to the proceeds of the original collateral (whether or not the security agreement even mentioned proceeds, let alone replacements, per 9-315(a)(2)) and to the proceeds of those proceeds (the replacement baseball, the insurance payout, whatever), so your student's "replacement" language is just surplussage. It is difficult if not impossible to draft a security agreement that covers ONLY one piece of collateral and would NEVER attach to anything else, and "replacements" will arguably count as "proceeds" in most instances, it seems to me. One could argue that we professors should be more aggressive about stamping out this kind of surplussage, but this strikes me as Quixotic--the industry will NEVER give up these kinds of unnecessary boilerplate phrases (witness the infamous ipso facto clause in residential leases, which has been ineffective since 1979).

In general, if a student comes up with a well thought out response that causes you as the instructor to have to re-evaluate the question that is often proof that the student really gets it.

I'm not really knowledgeable enough in this area to judge the particular answer but the reason you are asking the question in this forum would lead me to say it's a pass.

The student gets a fail, and not just because his agreement takes an interest in more than just the baseball. The student's answer is "cute," at best, and any client worth his billings knows that it takes an interest in more than "this object--the baseball--and nothing else." After all, what are "parts" and "accessories" if not something "else." The clause reads like a lawyer joke.

Moreover, since the clause exceeds the agreement, it's open to interpretation by a judge (who probably is a tennis man and doesn't even like baseball). In other words, your student didn't just fail the assignment, he exposed the client.

I disagree. I do not think that parts or accessories of a baseball would constitute an interest in something "else." What are the parts of a baseball? What are accessories of a baseball? Whatever the judge's sport of preference, I find it hard to believe a judge would interpret these terms as providing any practical significance with respect to a baseball.

As far as the replacement language goes, I tend to agree with Jared.

I would give the student a passing grade.

When we start talking about replacements, isn't there another question lurking here, namely whether some collateral is too unique to be replaced, and how do you describe the collateral? On the one end of the spectrum, if I take a security interest in the borrower's office equipment, it's reasonable that when the copier wears out the borrower will get a new copier and that's a replacement. So I want replacements to be covered. On the other hand, if borrower owns a particular Picasso, I want a security interest in THAT Picasso and I don't want to give borrower any ability to substitute another painting. Are all baseballs signed by Lou Brock equal in value? Probably not. So it's like the Picasso rather than the copier. But maybe it's not as easy to describe. The Picasso has a title. Isn't part of the challenge how do I describe this baseball to distinguish it from any other baseball with his signature on it?

I agree with FJP. Was the ball used in an actual game? Who pitched? Did Brock get a hit? A significant career landmark? Certainly not every baseball that Barry Bonds hit out of the park is equal in value. His *record-breaking and *record-setting home run balls are probably worth a lot more than home run 268 or what have you.

Isn't there also a question lurking of whether you have good title to the ball? (I know that doesn't affect the drafting issue in point.) I thought that the question of baseball ownership wasn't totally resolved in the Barry Bonds context.

Hopefully, Mr. Lawless didn't snatch the ball from the hands of anyone who may have obtained a pre-possessory interest a la Popov v. Hayashi, but even if he had caught the ball in the stands, the fact that Brock's signature is now on the ball probably denotes some kind of power of ownership.

To the uniqueness problem: If it's an unused, signed baseball that wasn't used in a particularly game or something significant, it would be lumped into a category of balls that were all more or less similar and therefore likely replaceable. To illustrate: if you were to go to a baseball memorabilia website (or show), you would likely see one price for a game-used Brock ball and one price for a regular signed baseball. A landmark ball would be the only kind that would likely vary from that.

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