The Secured Party’s Rights in a Debtor’s Bank Account under Section 9-306(4)(d) of the Uniform Commercial Code

Robert H. Skilton*

I. Introduction* 1 A debtor in a secured transaction coming under Article 9 of the Uniform Commercial Code,2 sells some of his inventory which is cover­ ed by a security agreement (for example, the debtor is an automobile dealer) or collects some of the accounts receivable he has assigned in a security agreement (for example, the debtor sells cotton goods to retail outlets on thirty days unsecured credit). The debtor receives “ cash pro­ ceeds” 3 in the form of money or checks payable to his order, from such

* Distinguished Visiting Professor of Law, McGeorge School of Law, University of the Pacific. A.B., 1930; M.A. 1931; LL.B ., 1934; Ph.D., 1943, University of Pennsylvania. 1. This article is a sequel to Skilton, Secured Party's Rights in a Debtor's Bank Account under Article 9 of the Uniform Commercial Code, 1977 S. I I I . U. L. J. 120 (hereinafter cited as Skilton). The introduction of the present article is a condensation of a part of the earlier article. 2. The Uniform Commercial Code is now the law in forty-nine states and the District of Columbia. Article 9 deals with security interests in personal property and fixtures. In 1972 the sponsoring bodies approved amendments to Article 9 (Illinois and Wisconsin have enacted the 1972 amendments, with modifications). A majority of states as of this time are still under the 1962 version. Section 9-306 (Proceeds) is one of the sections of Article 9 which were considerably changed in the 1972 version. The following presentation will be concerned with both versions of § 9306(4)(d). Unless otherwise indicated, citations are to the 1972 version of Article 9. 3. Section 9-306(1) (1972) of the Uniform Commercial Code provides: “ Proceeds" includes whatever is received upon the sale, exchange, collection or other disposition of collateral or proceeds. Insurance payable by reason of loss or damage to the collateral is proceeds, except to the extent that it is payable to a person other than a party to the security agreement. Money, checks, deposit accounts, and the like are “ cash proceeds." All other proceeds are "non-cash proceeds.” This version differs from the 1962 version of § 9-306(1), chiefly in specifically providing for the case of insurance payments, and in expressly including "deposit accounts" in the definition of "cash proceeds." As to "cash proceeds": § 1-201 (24) defines "money" in a narrower sense than some economics usage, but in a broader sense than legal tender, as "a medium of exchange authorized or adopted by a domestic or foreign government as a part of its currency." A “ check" is defined in § 3-104(2)(b) as “ a draft drawn on a bank and payable on demand." “ Deposit account" is defined in § 9-I05(l)(e). As to what may be

60 1978] The Secured Party’s Rights in a Debtor’s Bank Account 61 sale or collection, and instead of sending the proceeds intact to the secured party to apply to the secured debt, deposits the cash proceeds in his personal bank account. Sometimes the secured party consents to the debtor4 depositing the cash proceeds in his bank account, or at least has the matter brought to his attention by being paid by the debtor by checks drawn on this account, and so may be in the position of acquiescing in this practice. On the other hand, sometimes such deposit is in violation of the security agreement. If the debtor deposits in the same account funds not covered by the security interest, the proceeds so deposited may be said to be “ comming­ led.” From time to time, the debtor may draw upon this account for his own business and personal purposes. If we applied the tracing-trust funds principles associated with actual and constructive trusts, we would conclude that the secured party, like a beneficiary of an actual or constructive trust, could follow the proceeds subject to his interest into the debtor’s general bank account. Tracking the activity in the account through the lowest intermediate balance after the deposit of the cash proceeds would then enable the secured party to show that part of the cash proceeds which is still present in the account. Section 9-306 of the Uniform Commercial Code governs security interests in proceeds, and applies to the status of proceeds security interests in bank accounts (though section 9-104 provides that original security interests in bank accounts are not covered by Article 9). Section 9-306(2), however, indicates that if a secured party is to be accorded rights in proceeds, he must “ identify” the asset as proceeds from the disposition of collateral covered by the original security interest.5 For some time, there persisted a considerable opinion that “ identifi­

“ the lik e " (the residuary words) perhaps some bills of exchange payable on demand may be "the like" of checks, but not the typical note payable on demand. 4. Unless otherwise indicated, the term “ debtor" when used hereafter refers to the debtor in a secured transaction, who owes money to the secured party because the secured party has made a loan or sold goods to him on credit, and the term “ collateral” refers to the property made security by the security agreement. U.C.C. § 9-105( 1 )(c)(d). “ Cash proceeds” means cash proceeds received by the debtor from the disposal of collateral covered by a security agreement. 5. Section 9-306(2) (1962 and 1972) provides: Except where this Article otherwise provides, a security interest continues in collateral notwithstanding sale, exchange or other disposition thereof unless the disposition was authorized by the secured party in the security agreement or otherwise, and also continues in any identifiable proceeds including collections received by the debtor. It is reasonable to read a negative inference into § 9-306(2), and conclude that a "proceeds security interest" is lost when the proceeds cease to be identifiable. 62 Southern Illinois University Law Journal [1978:60 cation” meant something more than tracing; that it was the intent of section 9-306 that identification of a security interest in cash proceeds was lost when the debtor commingled the proceeds with his own assets, either by mixing money in a common till, or by depositing money or checks constituting cash proceeds subject to a security interest in his own bank account. Against this context, section 9-306(4)(d) was viewed as the one exception: in the event of insolvency proceedings, a limited right in the debtor’s bank account is accorded to the secured party. That subsection has undergone successive revisions, and the 1952, 1962, and 1972 versions are quoted in the accompanying footnote.* (i)*46 *(ii) To square the excep­ tion of section 9-306(4)(d) with the supposed basic rule of nonrecogni­ tion, this section was viewed as according only a limited proceeds security interest in ‘‘unidentified proceeds.” Be that as it may, a series of decisions of recent date now tilts the scales toward the view that a secured party does have a proceeds security interest in a debtor’s bank account, provided he can show that cash proceeds subject to his security interest were deposited by the debtor in

6. Section 9-306(2) (1952) provides: In insolvency proceedings a secured party with a perfected security interest has a right to the cash and bank accounts of the debtor equal to the amount of cash proceeds received by the debtor within ten days before the institution of such proceedings less the amount of such proceeds received by the debtor and paid over to the secured party during the ten day period, but no other right to or lien on cash proceeds not subjected to his control before insolvency proceedings are instituted. Nothing in this subsection shall affect any right of set-off which might otherwise exist. Section 9-306(4)(d) (1962) provides: (4) In the event of insolvency proceedings instituted by or against a debtor, a secured party with a perfected security interest in proceeds has a perfected security interest

(d) in all cash and bank accounts of the debtor, if other cash proceeds have been commingled or deposited in a bank account, but the perfected security interest under this paragraph (d) is (i) subject to any right of set-off; and (ii) limited to an amount not greater than the amount of any cash proceeds received by the debtor within ten days before the institution of the insolvency proceedings and commingled or deposited in a bank account prior to the insolvency proceed­ ings less the amount of cash proceeds received by the debtor and paid over to the secured party during the ten day period. Section 9-306(4)(d) (1972) provides: (4) In the event of insolvency proceedings instituted by or against a debtor, a secured party with a perfected security interest in proceeds has a perfected security interest only in the following proceeds:

(d) in all cash and deposit accounts of the debtor in which proceeds have been commingled with other funds, but the perfected security interest under this paragraph (d) is (i) subject to any right to set-off; and (ii) limited to an amount not greater than the amount of any cash 1978] The Secured Party’s Rights in a Debtor’s Bank Account 63 his bank account and remain present under tracing rules. This normal rule, it is conceived, is applicable to all issues as to which section 9- 306(4)(d) does not apply (i.e., to all cases which are not “ insolvency proceedings” ). So, for example, the normal rule applies to set-off dis­ putes involving the depositary bank; secured party versus the debtor’s attaching creditor; responsibility of depositary-drawee bank to secured party; secured party’s rights in assets purchased by debtor by use of bank account. The 1972 version of Article 9 moves the question into a revised section 9-306 which: (1) expressly identifies “ deposit account” as a form of “ cash proceeds;” (2) makes it clear that a “ deposit account” containing only cash proceeds covered by the security interest is not subject to the strictures of section 9-306(4)(d); (3) but still leaves open the question whether the secured party in cases where section 9-306(4)(d) does not apply (i.c., to all cases which are not “ insolvency proceedings” ) can “ identify” his security interest (as required by section 9-306(2)) after cash proceeds are deposited by the debtor in the debtor’s bank account and commingled with the debtor’s own deposits. It seems that the essential question remains the same as under the 1962 version, though some may think otherwise. It is probably still too early to say whether all courts will recognize that a secured party can follow his security interest into a debtor’s bank account in which cash proceeds have been commingled, and establish rights under Article 9, in a case not covered by section 9-306(4)(d). It is not the purpose of the present presentation to deal with the question of the existence of a so-called “ normal rule,” or with possible instances of its application. Such matters have been previously treated.7 Rather, the purpose is to focus upon section 9-306(4)(d). Nevertheless, in treating this section we must keep in mind the rights a secured party may have in his debtor’s bank account where section 9-306(4)(d) does not apply. Otherwise, proper evaluation of section 9-306(4)(d) is not possible.

proceeds received by the debtor within ten days before the institution of the insolvency proceedings less the sum of (I) the payments to the secured party on account of cash pro­ ceeds received by the debtor during such period and (II) the cash proceeds received by the debtor during such period to which the secured party is entitled under paragraphs (a) through (c) of this subsection (4). 7. See Skilton, supra note I . 64 Southern Illinois University Law Journal [1978:60

II. General Features of Section 9-306(4)(d) Section 9-306(4)(d) applies “ in the event of insolvency proceedings instituted by or against a debtor.’’ Insolvency proceedings include “ any assignment for the benefit of creditors or other proceedings intended to liquidate or rehabilitate the estate of the person involved.” 8 Proceedings under the Federal Bankruptcy Act9 are, of course, the most important type. Section 9-306(4)(d) thus states a special rule limited to “ insolvency proceedings” ; it is not more widely applicable to all cases involving insolvent debtors. Whether or not there should be a special rule limited to insolvency proceedings is the important question to be considered. Subject to certain conditions, the 1962 version of section 9- 306(4)(d) gives the secured party a perfected security interest in “ all cash and bank accounts of the debtor,” provided “ other cash proceeds have been commingled or deposited.” “ Other cash proceeds” means cash proceeds other than the cash proceeds referred to in subsection (4)(b) and (c). Subsection (4)(b) treats cash proceeds in the form of money “ which is not commingled with other money or deposited in a bank account prior to the insolvency proceedings.” Subsection (4)(c) treats cash proceeds “ in the form of checks and the like which are not deposited in a bank account prior to the insolvency proceedings.” 10 In both cases, if such cash proceeds are “ identifiable,” the secured party with a perfected security interest in proceeds may assert it in insolvency proceedings to the same extent that he could assert it if insolvency proceedings were not involved.11 However, in the event of insolvency proceedings, the commingling of cash proceeds consisting of money with other money belonging without restriction to the debtor, or the deposit of checks or money cash proceeds in the debtor’s bank account takes the case out of subsections (a), (b) and (c) of section 9-306(4) and puts it into section 9- 306(4)(d). Under the 1972 version of section 9-306(4)(d), commingling is likewise the trigger to activate application. Security interests in uncom­ mingled funds do not come within its coverage, but rather come within subsections (a), (b), or (c) of section 9-306(4). While commingling is a required event under both the 1962 and

8. Section 1-201(22). 9. II U.S.C. §§ 1-1255 (1970). 10. Subject to certain conditions, § 9-306(4)(a) (1962) and (1972) provides that the secured party has a security interest in “ identifiable non-cash proceeds" in the event of insolvency proceedings. 11. Section 9-306(2). 1978] The Secured Party’s Rights in a Debtor’s Bank Account 65

1972 versions, the two versions of section 9-306(4)(d) differ in several respects. Under the 1962 version, the security interest occasioned by commingling is perfected in all of the debtor’s money and bank accounts, and not just in the fund where commingling has occurred. In contrast, under the 1972 version, the security interest is perfected only in the debtor’s funds in which there has been a commingling. Other differences between the two versions will presently command our detailed attention. Meanwhile, it should be further noted that under either version of section 9-306(4)(d) the security interest therein recognized is limited to an amount not greater than “ the amount of any cash proceeds received by the debtor within ten days before the institution of insolvency proceed­ ings.’’ The 1962 version further limits this amount to such cash proceeds as have been commingled, or deposited in a bank account, as will be more fully explained later. This ten day limit places a severe constraint upon the availability and extent of the secured party’s claim under either version of section 9-306(4)(d). The limit of ten days, it seems, was designed to prod the secured party into exercising close supervision over the debtor’s handling of cash proceeds received and commingled.12 In contrast, no similar prod to policing is present if proceeds received by the debtor are not commingled or deposited in the debtor’s bank account. The secured party’s rights under subsections (a), (b), or (c) are not subject to the ten day cut-off provision. Thus, the ten day cut-off is one of the most notable and distinctive features of section 9-306(4)(d). Where it applies, section 9-306(4)(d) provides the exclusive re­ course. Thus, even if the secured party may trace cash proceeds received by the debtor from the disposition of collateral covered by a perfected security interest into the debtor’s bank account, the secured party has no effective claim to receipts prior to ten days of the institution of insolven­ cy proceedings, though they may be shown to be still present in the debtor’s bank account at the time of the institution of insolvency proceed­ ings.13

12. Why ten days? The draftsmen of the U.C.C. have sometimes displayed a liking for that figure, when they have deemed it wise to define the limits of a reasonable time. They had precedent for choosing ten days—for example, in the Uniform Trust Receipts Act, and the Uniform Conditional Sales Act. The inspiration of § 9-306(4)(d) was § 10(b) of UTRA. The ten days in 10(b) became the ten days of § 9-306(4)(d). Ten is, of course, an important number to human beings, beginning with ten toes and ten fingers. It is the basis of the decimal system. When used to define a commercially reasonable time, it translates roughly into a week of business days. For Code instances of the selection of ten days, see §§ 9-204(2), 9-312(4), 9-306(3), 2-702(2) and 2-502. 13. See. e.g., In re Gibson, 6 U.C.C. Rep. 1193 (Ref. W.D. Okla. 1969). The 1972 version is clearer. See Murphy & Peitzman, Without a Trace: The Secured Creditor's 66 Southern Illinois University Law Journal [1978:60

If the secured party is to have rights under section 9-306(4)(d), he must have a “perfected” security interest in “ proceeds.” Under the 1962 version of section 9-306(3), continuing perfection beyond ten days of a security interest in proceeds was normally accomplished by claiming “ proceeds” in a duly filed proper financing statement describing or identifying the collateral from whose disposal proceeds would result. Under the 1972 version of section 9-306(3) it is not necessary that “ proceeds” be claimed in such duly filed proper financing statement to accomplish continuing perfection. Perfection of a security interest in proceeds results in perfection of the security interest in commingled funds under section 9-306(4)(d). Attachment would not be enough, for the representative of creditors in insolvency proceedings is a “ lien creditor” (section 9-301(3)), and as such subordinates an unperfected security interest.14

A. Is a Special Bank Account Subject to the Ten-Day Rule of Section 9-306(4)(d)? The somewhat imprecise language of section 9-306(4) (1962) raises certain questions as to its application. If an item of proceeds comes within section 9-306(4)(a), (b), or (c), the result is generally advantage­ ous to the secured party, since the secured party’s claim on such item is not limited by the ten-day restriction of section 9-306(4)(d). In re JCM Cooperative, Inc. ,1S a decision by a referee in bankrupt­ cy applying the 1962 version of section 9-306(4), it appeared that the debtor, pursuant to the security agreement, had deposited cash proceeds from the sale of collateral in a special bank account. Withdrawal required a joint order of the secured party and the debtor. The special bank account consisted only of deposits of cash proceeds subject to the securi­ ty interest. The bank account was held to be “ identifiable non-cash proceeds,” covered by section 9-306(4)(a). The decision makes good sense. A literal reading of section 9- 306(4) (1962) might suggest that subsection (4)(d) applies (with its ten day limit) to any case where cash proceeds are deposited by the debtor in

Interest in Deposit Accounts, 49 Bankr. L.J. 303, 305 (1975). (However, where cash proceeds representing collection of an account receivable subject to a perfected security interest were collected and deposited in the debtor's general bank account subsequent to the filing of the petition, the amount of this deposit was added to the secured party's entitlement. In re Gibson, 6 U.C.C. Rep. 1193 (Ref. W.D. Okla. 1969)). 14. Section 9-30l(l)(b). See also § 70c of the Bankruptcy Act. Section 9-306(3) (1972) makes difficult reading. Sometimes a filing as to the original collateral will not suffice. See Skilton, supra note I, at 153-54. 15. 8 U.C.C. Rep. 247 (Ref. W.D. Mich. 1970). 1978] The Secured Party’s Rights in a Debtor’s Bank Account 67 a bank account (“ in all cash and bank accounts ‘of the debtor'16 if other cash proceeds have been commingled or deposited in a bank account.” )17 But the deposit of cash proceeds in a bank account which requires the signature of the secured party as well as the debtor for withdrawal can reasonably be held not a bank account “ of the debtor,” within the meaning of subsection (4), since the debtor does not have effective control over this account. It would seem reasonable to hold, as the referee did, that this asset fit into some other slot of section 9-306(4). The most likely slot would be subsection 9-306(4)(a): “ identifiable non-cash proceeds.” Under the 1962 version of section 9-306(4), a more difficult case is one where the debtor deposits cash proceeds in a separate account containing only cash proceeds, but retains full control over that account because withdrawal can be made on his signature alone. The debtor may or may not designate the account as a trust account; in any event, he deposits in this account only cash proceeds received from the sale or collection of collateral subject to the security agreement. Does the ten- day limit of section 9-306(4)(d) apply here? A California amendment to section 9-306(4) sought to make it clear that in any such case the secured party’s claim to this asset would continue without a ten day limit.18 The

16. Emphasis added. 17. That § 9-306(4)(d) (1962) applies only to the deposit of cash proceeds in a bank account " o f the debtor” seems clear, although the lim it of claim imposed by § 9-306(4)(d) refers to cash proceeds commingled or deposited in a bank account. 18. See Senate Fact Finding Comm, on Judiciary (1959-1961) Six t h jProgress Report to the L egislature, Part 1, T he U niform Commercial Code, to 1 Journal of the Senate, California (Regular Session, 1961), app., Report of Professors Harold Marsh, Jr. and William D. Warren, at 571, 572: Proposed Amendments. The State Bar Committee and the California Bank­ ers Committee propose to add a provision making clear a secured party’s right to a segregated bank account in which only the proceeds from the sale of his collateral have been placed. The California Bankers Committee also proposes to amend clause (d) of this subsection to restrict the right of the secured party to those bank accounts and cash in which proceeds have been commingled, rather than to “ all cash and bank accounts of the debtor.” The Credit Organizations Committee proposes to delete clause (d) of this subsection. Recommendation. It is recommended that the first two amendments be accepted, that the third amendment be rejected, and that clause (a) and the introductory portion of clause (d) of this subsection be amended to read as follows: “ (a) In identifiable noncash proceeds, and in a separate bank account containing only proceeds;" “ (d) In all cash and bank accounts of the debtor in which proceeds have been commingled with other funds, but the perfected security interest under this paragraph (d) is [clauses (i) and (ii) unchanged]." Discussion. This subsection deals with the situation where the debtor has sold the collateral pursuant to permission to do so in the loan agreement, but has not accounted to the secured party for the proceeds of sale at the time when insolvency supervenes. Under present law, the right of the secured party gener­ ally depends upon whether he can “ trace" the proceeds, and, this in turn, depends upon difficult and confusing doctrines regarding “ tracing" (e.g., first- 68 Southern Illinois University Law Journal [1978:60

Permanent Editorial Board opposed this change, on the somewhat spe­ cious claim that it was “ unnecessary” .19 Later, in the general overhaul-

in, first-out; non-trust-funds used first; etc.). The drafters of the Uniform Trust Receipts Act apparently attempted to give the secured party a lien upon “ all assets" of the debtor to the extent of proceeds received within 10 days prior to insolvency, but In re Crosstown Motors, In c., 272 F.2d 224 (7th Cir. 1959), held that that Act only created a State “ priority" which is invalid in bankruptcy. Contra: In re Harpeth Motors, 135 F. Supp. 863 (M. D. Tenn. 1955). This subsection solves the problem by eliminating the requirement of "trac­ ing’’ and clearly giving to the secured party a lien upon "all cash and bank accounts" of the debtor to the extent of proceeds received within 10 days of insolvency. The secured party also has a right to any “ identifiable" proceeds which have not been commingled with other funds. Presumably, where the proceeds have been commingled, the right of the secured party to “ trace" into a bank account beyond the 10-day period is lost, although the subsection does not expressly say so. It is not clear whether the term "identifiable noncash proceeds" would include a separate bank account in which the debtor is required to deposit proceeds and in which he deposits only proceeds. If not, then the right of the secured party to such a bank account would be limited under clause (d) to proceeds deposited in it within the 10-day period. Since such a bank account includes only “ his” money, certainly the secured party should have a right to it regardless of when the proceeds were received and this interpretation should not be left to inference. With respect to “ commingled" cash and bank accounts, the original clause (d) would give the secured party a lien to the amount of proceeds received within the 10-day period upon all cash and bank accounts o f the debtor, even though as to some or most of them it could be demonstrated that no proceeds had gone into them. In other words, suppose the debtor had four bank accounts, and he commingled proceeds in only one of them, which had a zero balance on the date of insolvency; the secured party would have a lien on the other three bank accounts in which no proceeds had been commingled. This seems to go too far in favoring the secured party over unsecured creditors. Therefore, the amendment proposed by the California Bankers Committee is recommended, which would limit this lien to those bank accounts in which commingling has occurred. The proposed amendment of the Credit Organization Committee would leave in effect the present law regarding “ tracing" with all of its uncertainties. We believe that the substitution of a simple and arbitrary rule such as that of the Code is preferable from the point of view of both the secured creditor and the unsecured creditors. This report did not recommend changes in the wording of § 9-306(4)(d)(ii). However, the Committee on the Uniform Commercial Code of the California Banking Association (id. at 428) recommended that § 9-306(4)(d) be amended to read: 11. Section 9-306(4)(d). Amend. (d) * * * in all cash and bank accounts of the debtor in which proceeds have been commingled with other funds, but the perfected security interest under this subparagraph (d) is (i) subject to any right of set-off; and (ii) limited to an amount not greater than the amount of any cash proceeds received by the debtor within ten days before the institution of the insolvency proceedings less the amount of cash proceeds received by the debtor and paid over to the secured party during the ten day period. The elimination from § 9-306(4)(d)(ii) of the words “ and commingled or deposited in a bank account” seems to have been a first step on the way to the language of § 9- 306(4)(d)(ii) which was finally enacted in California. See also Epstein, "Proceeding” Under the Uniform Commercial Code, 30 Ohio St . L.J. 787, 794 (1970). 19. Report No. 2 of the Permanent Editorial Board for the Uniform Commercial Code 211-12 (1964): Permanent Editorial Board Comment Reason for Rejection: In this variation California has sought to make clear that if commingling of cash proceeds has been avoided by depositing them in a separate 1978] The Secured Party’s Rights in a Debtor’s Bank Account 69 ing of Article 9, the California plan was adopted: the 1972 version of section 9-306(4) provides that in the event of insolvency proceedings “ A secured party with a perfected security interest in proceeds has a perfect­ ed security interest “ (a) in identifiable non-cash proceeds and in separate deposit accounts containing only proceeds.”20 This makes clear that in the event of insolvency proceedings the secured party has a “ security interest” not limited by the ten-day limita­ tion whenever there is a “ separate” bank account containing only pro­ ceeds, even though the account is in the debtor’s name, with the debtor designated without restriction as the signatory entitled to withdraw. It will have to be determined what constitutes a “ separate” bank account; certainly the debtor’s general account which he uses for deposits of his own funds should not suffice, though at the time of bankruptcy it may contain only proceeds. Viewed on the merits, a decision that a bank account containing cash proceeds is not subject to the ten-day limitation of section 9- 306(4)(d) in the event of insolvency proceedings makes good sense, where the account requires the joint signature of the secured party and the debtor for withdrawals. The ten-day limitation of section 9-306(4)(d) may serve some purpose by encouraging a secured party to “ police” transactions and insist on the debtor promptly remitting cash proceeds. Deposit of cash proceeds in an account requiring the secured party’s signature effectively removes the proceeds from unsupervised use by the debtor. In fact, if the joint signature of the secured party is required to effect withdrawals, there seems to be no good reason to subject such bank account, containing proceeds, to the ten day limit simply because it may contain non-proceeds as well. In this respect, section 9-306(4)(d) (1972) may not go far enough. Section 9-306(2) of the 1952 version, the predecessor of section 9- 306(4)(d), expressly limited its provisions to cash proceeds not subjected to the secured party’s control. Thus, 1952 section 9-306(2) would seem to apply to a separate account containing only proceeds, withdrawable on

bank account containing only proceeds, the cash involved is subject to the same rule as that applicable to identifiable non-cash proceeds and undeposited cash proceeds, rather than the rule applicable to commingled cash. California’s prob­ lem is no doubt suggested by the exclusion under section 9-104(k) o f “ transfers . . . of any deposit . . . or like account maintained with the bank . . . But this exclusion in 9-104 must be read with 9-306, which clearly covers bank accounts containing non-proceeds and by implication, aided by the general definition of “ proceeds,” it must be read as California has more clearly stated it. In short, California has only made explicit what is otherwise the necessary construction of the statute. See Mellinkoff, The Language of the Uniform Commercial Code, 77 Y ale L.J. 185, 224 (1967) (making caustic comments on the positions of the Permanent Editorial Board). 20. Emphasis added. 70 Southern Illinois University Law Journal [1978:60

the sole signature of the debtor. Yet the 1972 version of section 9- 306(4)(a) would remove this situation from the ten-day limit of section 9- 306(4)(d).

B. Section 9-306(4)(d)— Is It Worthwhile? As In re JCM Cooperative, Inc.2' indicates, it may be of vital consequence to the secured party that cash proceeds received by the debtor come within subsections 9-306(4)(a), (b), or (c), and not within section 9-306(4)(d). It is now time to deal with some of the problems raised by section 9- 306(4)(d) where it applies. It shall be my task to deal with: (a) Calculation problems: The way in which the amount of the secured party’s claim under section 9-306(4)(d) is determined; (b) The difference between the amount of the claim and the fund subject to the claim under section 9-306(4)(d); (c) The extent to which section 9-306(4)(d) eliminates the secured party’s need to trace; (d) Questions raised under the Federal Bankruptcy Act by applica­ tion of section 9-306(4)(d); and (e) Certain logical inconsistencies in the provisions of section 9- 306(4)(d). If the reader is convinced by the following presentation that, con­ sidering calculation problems, bankruptcy questions and logical inconsis­ tency, section 9-306(4)(d) is not worthwhile, then he should be prepared to conclude that something should be done about it. What should be done will be left for the conclusion.

III. Some Problems in Calculating the Secured Party’s Claim Under Section 9-306(4)(d) To calculate the minuend,21 22 one must determine what is meant by “ cash proceeds” received by the debtor in the final ten days, within the meaning of section 9-306(4)(d). Suppose that in the final ten days before insolvency proceedings begin the debtor receives and deposits a check for $1,000 of cash proceeds received from the sale of inventory covered by a perfected security interest, and also deposits $9,000 from other unrelated sources. At the time of the institution of the insolvency proceedings, the account

21. 8 U.C.C. Rep. 247 (Ref. W.D. Mich. 1970). 22. The maximum number from which the amount of a secured party's security interest in commingled proceeds can be computed. 1978] The Secured Party’s Rights in a Debtor’s Bank Account 71 balance is $10,000. Is the tentative amount of the secured party’s security interest under section 9-306(4)(d) $1,000 or $10,000? A panel of the Seventh Circuit, construing the 1962 version, held for $1,000. “ Cash proceeds” referred to in section 9-306(4)(d) was held to mean “ cash proceeds” as defined in section 9-306(1), that is, cash proceeds derived from the disposition of collateral subject to the security interest.23 On the other hand, a panel of the Ninth Circuit would hold for $10,000, and then proceed to apply section 60 of the Bankruptcy Act24 to the $9,000 which did not represent a deposit of cash proceeds derived from the disposition of collateral subject to the security interest.25 In the Ninth Circuit case it appeared that the debtor had deposited $19,505.37 in his bank account in the last ten days, only $10 of which was traced as cash proceeds received from the sale of property covered by a perfected security interest. And yet the court construed section 9-306(4)(d) so as to include all of the $19,505.27 as cash proceeds subject to the secured party’s claim! Taking this line, any deposit from any source becomes “ cash proceeds” under section 9-306(4)(d). The court then applied section 60 to the Bankruptcy Act to all but $10 and reduced the secured party’s priority to $10. In my view, the Ninth Circuit reading is erroneous in its view that “ cash proceeds” in section 9-306(4)(d) does not have the same meaning as “ cash proceeds” in section 9-306(1). The reasoning of the court was that “ any cash proceeds” used in the phrase (in section 9-306(4)(d) (1962)) “ limited to an amount not greater than the amount of any cash proceeds received by the debtor within ten days,” did not mean “ cash proceeds” as defined in section 9-306(1), that is, “ cash proceeds” received from the disposal of collateral subjected to the security interest. It argued that the term as used in section 9-306(1) referred to cash proceeds that could be “ identified,” as required by section 9-306(2), and not to a case covered by section 9-306(4)(d) where commingling through deposit in the debtor’s account resulted in loss of identifiability. Taking this view of section 9-306(4)(d) (1962), the secured party’s claim became a claim to any deposits made by the debtor in the last ten days, regardless of source and irrespective of whether or not any of the deposits represent­ ed cash proceeds derived from the disposal of collateral. “ Any cash proceeds” in section 9-306(4)(d) translates into “ any deposits.” Even a

23. Fitzpatrick v. Phiico Finance Co., 491 F.2d 1288, 14 U.C.C. Rep. 12 (7th Cir. 1974). 24. 11 U.S.C. § 96; Bankruptcy Act, § 60, which concerns voidable transfers occur­ ring within four months of bankruptcy. 25. Arizona Wholesale Supply Co. v. Itule (In re Gibson Products), 543 F.2d 652 (9th Cir. 1976). See Note, Bankrupting the Proceeds Section: Recent Interpretation o f Section 9-306(4)(d) o f the Uniform Commerical Code, 55 T exas L. Rev. 891 (1977). 72 Southern Illinois University Law Journal [1978:60

Christmas gift check when deposited becomes “ cash proceeds.” Is it conceivable that the draftsmen so intended? I assume they did not. Even if we concede that “ cash proceeds” as used in section 9-306(1) refers to “ identifiable” cash proceeds, and that upon commingling the item re­ ceived by the debtor is no longer “ cash proceeds” as defined in subsec­ tion 9-306(1) because no longer “ identifiable,” until commingling the item is identifiable cash proceeds. Upon its receipt by the debtor it is section 9-306(1) cash proceeds, although after its deposit, or at least after its collection, it ceases to be identifiable cash proceeds (arguendo) because commingled as part of that bank’s debt to the depositor. So I read the phrase “ limited to an amount not greater than the amount of any cash proceeds received by the debtor” as being perfectly consistent with “ identifiable” cash proceeds as defined in Section 9-306(1), because at least at the time the debtor received the “ cash proceeds” under anyone’s view they were identifiable. I do not disparage the view that upon deposit in the debtor’s general bank account, the cash proceeds ceased to be identifiable cash proceeds through commingling (although the present trend of authority is to the contrary), but whether they remain identifiable after deposit has nothing to do with the status before deposit, and this is all that we need be concerned with here. In holding that the secured party’s section 9-306(4)(d) security interest was subject to avoidance under section 60 of the Bankruptcy Act except to the extent of “ cash proceeds” traceable to the disposal of original collateral, the opinion raises more questions than it answers. In the Ninth Circuit case the result was to sustain the secured party’s claim only to the extent of $10. But voidability under section 60 depends’ inter alia, upon the debtor’s trustee in bankruptcy’s ability to show that at the time a preference is received, the preferred party (here, the claimant of a security interest) had reason to believe that the transferor (the debtor) was insolvent at the time of the transfer.26 Thus, the Ninth Circuit view raises the serious potential that a secured party’s claim in a debtor’s bank account may be greatly expanded at the expense of the unsecured cred­ itors of the debtor, by reason of the trustee in bankruptcy’s inability in some cases to show (as required by section 60b of the Bankruptcy Act) that at the time of receipt of an item of “ cash proceeds” by the debtor, the secured party had reason to believe that the debtor was insolvent. This potential depends on a view that the time of transfer of the security interest in that item is not the time of the institution of bankruptcy proceedings, but rather the time of the debtor’s receipt, or prior thereto.

26. Section 60(b) o f the Bankruptcy Act. Caveat: The proposed new Bankruptcy Act would substantially change the rules regarding voidable preferences, including abolition of the "reason-to-believe" requirement in the ninety days prior to the petition. 1978] The Secured Party’s Rights in a Debtor’s Bank Account 73

A. “Less Than The Amount” A referee in bankruptcy’s decision, In re Security Aluminum Co. ,27 deals with the meaning of the words “ less than the amount of cash proceeds received by the debtor and paid over to the secured party within the ten-day period” in the 1962 version of section 9-306(4)(d)(ii). It appeared that during the ten-day period immediately prior to the filing of a petition in bankruptcy the debtor had received approximately $62,000 in cash proceeds subject to a perfected proceeds security interest in favor of an accounts receivable financier. About half of this amount, in the form of checks, (identifiable cash proceeds—section 9-306(4)(c)) was turned over intact to the secured party. The other half was deposited in the debtor’s bank account. The trustee in bankruptcy claimed that accordingly the secured party had no claim on the debtor’s bank ac­ count—interpreting the formula of section 9-306(4)(d) (1962) to arrive at zero. Referee Brody disagreed: Paragraph (4) [of section 9-306] deals with the right of creditors to reach both identifiable and non-identifiable proceeds in the event of insolvency proceedings. With respect to identifiable proceeds, whether such proceeds are cash or non-cash proceeds, the inter­ est of a creditor who has a perfected interest in proceeds is not affected by the insolvency proceedings. Sub-paragraph (a), (b) and (c) of Paragraph 4. With respect to non-identifiable (commingled) proceeds subparagraph (d) of Paragraph 4 has sub­ stituted for conventional tracing techniques a formula designed to determine the extent of a secured party’s protected interest in proceeds [citing Gilmore and Henson], The sections of Paragraph 4 dealing with identifiable proceeds and the section dealing with non-identifiable proceeds are addressed to separate problems and the language employed in these sections must be read in light of the problems involved and the legislative solution adopted. Since Paragraph 4(d) is concerned with the extent to which a creditor may reach commingled funds it would seem appropriate to as­ sume that the computations required by Paragraph 4(d) would relate solely to commingled funds especially in the absence of any indication that the draftsmen did not so intend. To hold otherwise would yield results that are inequitable and which cannot be justified on any rational basis. A consideration of several hy­ pothetical cases brings into focus the lack of rationality and the inequity which would result if the trustee’s position were adopted.

Case I. The debtor during the ten day period prior to the institu­ tion of insolvency proceedings receives $31,534.70 which is

27. 9 U.C.C. Rep. 47 (Ref. E.D. Mich. 1971). Professor Epstein forecast this result; see Epstein, supra note 18, at 795-96. 74 Southern Illinois University Law Journal [1978:60

commingled in a bank account and $31,700.94 in checks is still in the possession of the debtor. Here clearly the secured creditor would have a secured interest to the extent of $63,235.64 consist­ ing of $31,700.94 in checks as identifiable proceeds by virtue of sub-paragraph (c) of MSA 19.906(4) and the $31,534.70 by virtue of sub-paragraph (d)(ii) of the same section. Case II. The debtor during the 10 day period prior to the institu­ tion of insolvency proceeding receives $63,235.64 which it commingles in a bank account. The debtor pays over from this account $31,700.94 to the secured creditor. At the time that the insolvency proceeding is instituted $31,534.70 is still in the ac­ count. By virtue of sub-paragraph (d)(ii) of MSA 19.9306(4) the creditor has a secured interest in the $31,534.70 still on deposit. Therefore, of the $63,235.64 received by the debtor during the relevant 10 day period the entire amount will be ultimately re­ ceived by the secured creditor. There is nothing that distinguishes the present case from the two hypotheticals other than the manner of payment to the creditor and yet if the trustee’s argument is accepted the return to the creditor in the case before the court will be decreased by $31,700.64 merely because of the manner of distribution. . . . A statute is to be interpreted in a manner that is reasonable and takes into account the legislative purpose, United States v. Ryan, 284 U.S. 167. To relate all computations required by subparag­ raph (d) to commingled funds gives effect to the language used by the legislature and is consistent with the purpose sought to be accomplished.28 Thus the referee’s analysis resulted in the secured party having a claim under section 9-306(4)(d) for about $32,000 rather than zero. The difficulty occasioning the referee’s analysis was that the formu­ la of section 9-306(4)(d) (1962) literally required taking the amount which is the sum of cash proceeds received by the debtor within ten days before the institution of insolvency proceedings and commingled or deposited ip a bank account. This, the minuend, would amount to about $32,000 under the facts of the case. But the subtrahend29 was: “ less the amount of cash proceeds received by the debtor and paid over to the secured party during the ten day period.” Thus, cash proceeds in the subtrahend would include about $32,000 in checks turned over intact to the secured party. So construed, the scope of the subtrahend would obviously be larger than the scope of the minuend. (Minuend: subpart (d)

28. 9 U.C.C. Rep. at 51-52. 29. The number to be subtracted from the maximum number (minuend) from which the amount o f a secured party's security interest in commingled proceeds can be computed. 1978] The Secured Party’s Rights in a Debtor’s Bank Account 75 receipts. Subtrahend: payments from subparts (a), (b), (c), and (d) receipts of cash proceeds). And therein lay the potential for absurdity, as revealed in the referee’s opinion. Like comparing apples with oranges.

B. The Minuend and the Subtrahend: 1972 Version A California amendment subsequently adopted verbatim in the 1972 version of section 9-306(4)(d) avoided this difficulty by making the minuend and the subtrahend coextensive in area. Under section 9- 306(4)(d) (California and the 1972 version of the U.C.C.) the minuend is “ the amount of any cash proceeds received by the debtor within ten days before the institution of the insolvency proceedings’’ and not just subpart (d) receipts. The limitation in the minuend to commingled and deposited cash proceeds was dropped. The subtrahend was the sum of payment of cash proceeds to the secured party from subparts a, b, c and d, on account of cash proceeds received by the debtor in the last ten days plus “ the cash proceeds received by the debtor during such period to which the secured party is entitled under sub-paragraphs (a) through (c) of this subsection (4).” Is this formula a convoluted way of coming to the same result as if the minuend were subpart (d) assets, and the subtrahend were payments to the secured party from subpart (d) assets? (That was basically the referee’s construction of section 9-306(4)(d) (1962) in In re Security Aluminum). To answer this question let us consider the following hy­ pothetical case, and call it Case IV, to distinguish it from the three cases discussed in connection with In re Security Aluminum. Case IV. Debtor receives in the last ten days prior to the filing of the petition in bankruptcy $30,000 in cash proceeds covered by a perfected proceeds security interest. He deposits $15,000 of this in a separate bank account (section 9-306(4)(a) (1972)) containing only proceeds, and within the next few days withdraws this entire amount to pay various creditors. He deposits the other $15,000 in this general banking account, which at the time of the filing of the petition in bankruptcy has a balance of $30,000. How much is secured party’s claim on the general bank account under section 9-306(4)(d) (1972)? Answer: Either $30,000 or $15,000, depending on the construc­ tion of the words in the subtrahend to which the secured party is entitled under subparagraphs (a) through (c) of section 9-306(4). If, because of the withdrawals, we say that the secured party is no longer entitled to anything in the separate bank account, the answer is: $30,000. Minuend: $15,000 subpart (a) receipts plus $15,000 subpart (d) receipts = $30,000. Subtrahend: 0. No payment to secured party from subpart (a) or subpart (d) receipts and no entitlement to subpart (a) receipts. 76 Southern Illinois University Law Journal [1978:60

As I analyze the 1972 Amendment to section 9-306(4), the three cases (two of them hypothetical) treated by Referee Brody in In re Security Aluminum Co. would come out in accordance with his interpre­ tation of the 1962 version of section 9-306(4)(d). However, if the answer to my above hypothetical is $30,000, it seems a new twist has been added, for Referee Brody as I see it would interpret the 1962 version of section 9-306(4)(d) to make all transactions involving subparts (a), (b) and (c) of section 9-306(4) irrelevant, and so he would come to an answer of $15,000. Well, one may ask, have not the draftsmen of the 1972 version gone out of their way in making simple things difficult by adopting this rather complicated formula which requires us to take into account all cash proceeds receipts in the last ten days and deduct therefrom all payments to the secured party made from such receipts and all entitlements? Would it not have been simpler to have said “ subpart (d) receipts less subpart (d) payments’’? Not really. Not if case IV’s answer is $30,000, and $30,000 is, I believe, the proper answer. Under the 1962 version of section 9-306(4)(d) if cash proceeds were deposited in a bank account under the control of the secured party, he might claim under section 9-306(4)(a). Further if the secured party could identify cash proceeds as still being present in the form of money not commingled, he could claim under section 9-306(4)(b); and if the se­ cured party could identify cash proceeds as undeposited checks, he could claim under section 9-306(4)(c). Finally, if such cash proceeds were received by the debtor in the final ten days and had been commingled with other money or deposited in the debtor’s bank account, the secured party could claim under section 9-306(4)(d). But suppose it was not known what happened to the cash proceeds after receipt, or suppose as in case IV above it appeared that the debtor had spent the money without first commingling it or cashed the check without first depositing it in his account and spent the proceeds of the check? The 1962 version of section 9-306(4)(d) provides that the subsection 4(d) claim is “ limited to the amount of any cash proceeds received by the debtor within ten days before the institution of insolvency proceedings and commingled or deposited in a bank account . . . ,”30 Thus, case IV would give the secured party no right under section 9-306(4)(d) (1962). The amount of vanished cash proceeds which cannot be shown to have been first commingled or deposited before vanishing does not enter into the deter­ mination of the secured party’s claim. Thus, if my reading is correct, there is a substantial difference

30. Emphasis added. 1978] The Secured Party’s Rights in a Debtor’s Bank Account 77 between the 1962 and 1972 versions of section 9-306(4)(d) in the manner of calculating the minuend and subtrahend. Is it reasonable to limit a subsection (4)(d) claim to such sums as are first commingled or deposit­ ed before being spent, since the subsection is completely unconcerned with what happens to those particular funds after commingling? The 1972 version of section 9-306(4)(d) answers the question in the negative. The amount of the claim of the secured party under this subsection shall be determined on the basis of all cash proceeds received by the debtor in the last ten days. “ All cash proceeds” includes case IV above. The secured party’s tracing problems are simplified since the “ and comming­ led or deposited in a bank account” requirement is dropped from the formula. Logically, the scope of the subtrahend should be equal to the scope of the minuend, and it is, in the 1972 version.

IV. The Extent of the Claim Versus the Fund Subject to the Claim The above remarks have been concerned with calculating the amount of the secured party’s claim under section 9-306(4)(d). There is the separate question as to the amount of the debtor’s assets that are subject to the secured party’s section 9-306(4)(d) security interest. Logic would seem to suggest that the same considerations which may have led to the dropping in the 1972 version of the commingling requirement in determining the amount of entitlement would carry over into determining the nature of the bag from which the secured party may take the value of his claim: that it should be all of the debtor’s cash and bank accounts. But not so. It is “ All cash and deposit accounts of the debtor in which proceeds have been commingled with other funds.” So the “ commingl­ ing” limitation now applies to the bag, although not to the amount that may be claimed from the bag. Odd? In contrast, the 1962 version applies the “ commingling” limitation to the amount that could be claimed, but not to the bag, although even there some commingling in some of the assets involved would seemingly have to take place.

A. Tracing It is frequently asserted that section 9-306(4)(d) eliminates the need for tracing. This assertion is not entirely true.31 It would be more correct to say that while section 9-306(4)(d) modifies tracing requirements, it nevertheless imposes a substantial burden upon the secured party to establish his security interest.

31. This analysis is based on the assumption that the burden of proof is upon the secured party, rather than the trustee in bankruptcy. 78 Southern Illinois University Law Journal [1978:60

As to what the secured party must prove, the 1962 and 1972 versions of section 9-306(4)(d) differ. Under the 1962 version, the secured party must show: (1) that cash proceeds were received by the debtor within the last ten days prior to the institution of insolvency proceedings, and (2) that such cash proceeds were commingled with other money, or deposited in the debtor’s bank account. This being established the secured party may to the extent of (2) assert a claim against all of the debtor’s cash and bank accounts existing at the commencement of insolvency proceedings. Under the 1972 version, the secured party must show: (1) that cash proceeds of a certain amount were received by the debtor within ten days of the institution of insolvency proceedings. But to establish that a security interest under section 9- 306(4)(d) attached to and is perfected in a fund, he must (2) show that the fund in question was one where commingling of cash proceeds received within the final ten days had taken place. Thus, under either version the secured party must be able to trace, to a certain extent. To some extent, however, normal tracing rules are dispensed with. Under the 1962 version, the security interest, once established, attaches to and is perfected in all cash and bank accounts of the debtor remaining at the institution of insolvency proceedings, even in cash and bank accounts in which no commingling has occurred. Under the 1972 ver­ sion, the security interest attaches to and is perfected in only such cash and bank accounts as have been subjected to commingling, but the extent of the security interest is not limited to the amount of cash proceeds entering into the commingled fund. Most importantly, normal tracing rules are modified in that neither version calls for application of the lowest intermediate balance rule to curtail the amount of the traceable claim. Thus, even if the debtor’s trustee in bankruptcy could show that cash proceeds in the amount of $1,000 were received by the debtor in the last ten days, and deposited in his bank account, and that two days after deposit the debtor withdrew all but $10 from the account, and three days after the withdrawal the debtor deposited in the account $1,000 of his own funds—all within the final ten days—the secured party’s section 9-306(4)(d) $1,000 claim on the bank account would be reinstated. It must be borne in mind, however, that the ten day limit of section 9-306(4)(d) works in the other direction, to limit the secured party’s claim, even when under normal rules he can trace. Thus the relaxation of tracing rules may be regarded as a trade-off. Since the ten day span is so short, it may not be too much to assume that subsequent deposits are so often related to earlier withdrawals that a “ relaxed substitution’’ ap­ proach is in order. The ten day limit gives some justification for moderat­ ing tracing rules. 1978] The Secured Party’s Rights in a Debtor’s Bank Account 79

Certain points seem to stand out: (1) The convolutions of the formula for ascertaining the extent of the secured party’s claim (calculating the minuend and the subtrahend) under either the 1962 or the 1972 version of section 9-306(4)(d) are exasperating and invite controversy in application. (2) The proclaimed benefits of section 9-306(4)(d) in eliminating problems of tracing and thus reducing costs, can be easily exaggerated. Where cash proceeds are shown to have been deposited in the debtor’s bank account it is generally not difficult to trace through the bank account, by inspection of readily available records, to determine whether or not cash proceeds deposited in it still remain.

B. “ Subject to Any Right of Set-Off” In a well reasoned opinion, the Superior Court of Pennsylvania held that the above phrase in the 1962 version of section 9-306(4)(d) (repeated in the 1972 version) was not intended to establish that a bank’s set off rights were superior to the secured party’s claim, but rather to continue unchanged the idea better expressed in the 1952 version, which included the qualifying words “ which might otherwise exist.” 32 It was held that what set-off rights the bank might have vis-a-vis the secured party’s claim depended on the state of the law in Pennsylvania prior to adoption of the U.C.C., and this law was found to be in favor of the secured party, regardless of whether or not the bank knew or had notice of the secured party’s claim at the time of set off. In the opinion of the court, judgment in favor of the secured party was indicated because the entire amount of the bank account involved in the set off was clearly traceable to a deposit of cash proceeds received by the debtor from collection of an account in which the secured party had a perfected security interest. The court recognized that under section 9-306(4)(d) cases could arise where the secured party’s rights would be in deposits not represent­ ing traceable cash proceeds; whether the set-off rights of the bank would be in such cases superior was left open: We need not decide whether or not any new right of the security holder, created by the code, might be held subject to a right of set off under the language of section 9-306. Certainly, where the factor’s [i.e., the lender’s] funds are clearly traced into the ac­ count of the depositor, as here, and the security holder would be

32. Middle Atlantic Credit Corp. v. First Pa. Banking and Trust Co., 199 Pa. Super. 456, 185 A .2d 818 (1962). See also Morrison Steel Co. v. Gurstman, 113 N. J. Super. 474, 274 A .2d 306 (1971). 80 Southern Illinois University Law Journal [1978:60

entitiled to recover funds prior to the code without any right of set-off in the bank, the code creates no new right of set-off.”

V. Section 9-306(4)(d) and Bankruptcy Legislation depending upon state power will fall before superior Congressional power if: (1) the federal legislation is a valid constitutional exercise of federal power, and (2) the Congressional Act contradicts the state legislation, or preempts the area treated by the state legislation.33 34 Let us focus upon various provisions of the federal Bankruptcy Act, insofar as they may put in question the validity of section 9-306(4)(d), at least with respect to some of its applications. The question is, whether a right in the debtor’s assets given by state legislation to a “ secured party’’ which arises only in the event of insol­ vency proceedings, runs afoul of the federal Bankruptcy Act? Obvious­ ly, a state law giving a “ security interest’’ which applies only in the event of insolvency proceedings, and not otherwise, runs the risk of being held to be an impermissible interference with the federal Bankrupt­ cy Act provisions. In what way does section 9-306(4)(d) purport to affect the outcome in bankruptcy proceedings? If (contra to what now seems the trend of authority) a court should decide that a security interest in cash proceeds is discontinued under Article 9 upon commingling, because commingling results in loss of identification except where section 9-306(4)(d) applies, all applications of section 9-306(4)(d) to bankruptcy proceeds would be suspect. But let us assume (as seems to be the trend of authority) that the secured party, if he can trace cash proceeds subject to a perfected proceeds security interest into the debtor’s bank account, or into the debtor’s commingled cash, has enforceable rights in the bank account or commingled cash, where insolvency proceedings are not involved. If so: (1) In some cases, section 9-306(4)(d) gives nothing and takes nothing away from what the secured party would have, in the absence of insolvency proceedings.35

33. 199 Pa. Super, at 460-61, 185 A .2d at 820. The foregoing effort to decipher § 9- 306(4)(d) and explain its calculation scheme has led me more than once to wonder whether I have correctly analyzed. If the reader can do better, fine. If, however, the reader comes out of this presentation with a certain amount of exasperation and confusion, perhaps he should direct his irritation not at me, but at the arcane provisions of § 9-306(4)(d). 34. 11 U.S.C. § 1. The Constitution vests in Congress the power to enact a uniform law of bankruptcy, as well as power to enact legislation regulating interstate commerce and matters affecting interstate commerce. Subject to limitation on Congressional power in the Bill of Rights, these powers among others give Congress ample basis for provisions relating to the liquidation or rehabilitation of the estate of an insolvent. 35. On December I, Debtor deposits in Account #1 cash proceeds received by 1978] The Secured Party’s Rights in a Debtor’s Bank Account 81

(2) In some cases, it gives less.36 (3) In some cases, it gives more.37 Where it gives nothing or gives less, there is no apparent conflict with the Bankruptcy Act. But to the extent, in given situations, section 9-306(4)(d) adds to (rather than limits') the rights that the secured party would have in identifiable, traceable proceeds from the disposition of collateral, does it conflict with the federal act’s distributive provisions, notably—section 64,38 dealing with priorities of payment; section 67,39 invalidating certain statutory liens; and section 60,40 dealing with preferences? If conflict is found, it inevitably follows that all conflicting applica­ tions of section 9-306(4)(d) are invalid. It does not follow, however, that

Debtor the same day. Secured Party had a perfected security interest in these cash proceeds. At the time the petition in bankruptcy is filed against Debtor (December 5) Account #1 is sufficient and since December I has always been sufficient in amount to cover the December I deposit in full. Here § 9-306(4)(d) (1962 and 1972) does not add to Secured Party’s rights. 36. On December I , Debtor deposits in Account # I cash proceeds received by debtor on the same day. Secured Party has a perfected security interest in these cash proceeds. On December 15, a petition in bankruptcy is filed against Debtor. Though Account # I has at all times since December 1 remained large enough to include the December 1 deposit in fu ll. Secured Party has no rights in this account. Here § 9-306(4)(d) (1962 and 1972) deprives the Secured Party of what he would otherwise have. 37. On December I, Debtor deposits in Account #1 cash proceeds received by Debtor on the same day. Secured Party has a perfected security interest in these cash proceeds. Account #1 is exhausted at the time a petition in bankruptcy (December 5) is filed against Debtor. But Debtor also maintained Account #2, which does have a balance. 1962's § 9-306(4)(d) seems to say that the Secured Party has a perfected security interest in Account #2 to the extent of the December I deposit in Account #1. Except for insolven­ cy proceedings he would not have a security interest in Account #2—there being no proceeds traceable into this account. Here 1962 § 9-306(4)(d) gives rights which Secured Party would not otherwise have. In contrast, the 1972 version of § 9-306(4)(d) gives the Secured Party rights only in all cash and deposit accounts of the debtor "in which proceeds have been commingled with other funds." 38. II U.S.C. § 104, 197(c). The 1952 version of § 9-306(4)(d) (§ 9-306(2) [1952)) described the secured party's section 9-306(2) rights as a "p rio rity ." Eventually, the term "security interest" was substituted for the term "p rio rity ." The change was “ to negate the idea that a security interest under Article 9 is a statutory lien in line with the case of fn re Tele-Tone Radio Corp., 133 F. Supp. 739 (D.N.J. 1955)." 39. 11 U.S.C. § 107. See S. Rep. No. 1159, 89th Cong., 2d Sess. 6, reprinted in [1966] U.S. Code Cong. & A d. N ews 2456, 2461: The first of these provisions strikes at liens which merely determine the order of distribution upon insolvency or liquidation. This kind of lien is not a specific property right which may be asserted independently o f a general distribution and regardless of the transfer of the property. This is clearly a disguised priority. 40. II U.S.C. § 96. Section 60a( 1) provides: A preference is a transfer, as defined in this Act, of any of the property of a debtor to or for the benefit of a creditor for or on account of an antecedent debt, made or suffered by such debtor while insolvent and within four months before the filing by or against him of the petition initiating a proceeding under this Act, 82 Southern Illinois University Law Journal [1978:60 the subsection is deprived of legal effect in its application to nonconflict­ ing situations. For example, in cases where the debtor’s bank account may be shown to consist entirely of traceable cash proceeds, section 9- 306(4)(d) when applied would confer nothing more than the secured party would have apart from insolvency proceedings, if we follow what seems to be the trend of authority; in fact, because of the ten-day limitation, it would sometimes confer less. Would a state law which provides that a secured party may get less in insolvency proceedings than he would otherwise have be offensive to the distributive provisions of the federal Bankruptcy Act? It is doubtful that it would be. If, then, section 9-306(4)(d) would be found to conflict with federal law only as to some of its applications, it is unlikely that it would be treated as the kind of overreaching statute which is entirely invalid.

A. Section 64 Bankruptcy Act Section 64 of the national Bankruptcy Act sets forth an order of priority in the distribution of a bankrupt’s estate. The interest accorded to the secured party under section 9-306(4)(d), though called a “ security interest’’ (and if truly such, section 64 would not apply) applies only in the event of insolvency proceedings. To the extent that section 9- 306(4)(d) takes away from the secured party rights in commingled funds that he would otherwise have, I see no Bankruptcy Act objections. But to the extent that section 9-306(4)(d) gives something additional to the secured party to what he would have if insolvency proceedings were not involved, there is a very reasonable argument that section 9-306(4)(d) is an officious intermeddling, an attempt to give the secured party a posi­ tion in the pecking order of distribution which is preempted by section 64 of the Bankruptcy Act. Under the 1962 version of section 9-306(4)(d), additional rights are conferred: (1) in giving the secured party a security interest in all money and bank accounts of the debtor, (provided there has been commingling in any part) and not simply in cash and bank accounts in which cash proceeds have been commingled; (2) by elimination of the tracing rule of lowest intermediate bal­ ance, at least in any state which would apply that limitation to the secured party’s claim on commingled assets if insolvency proceedings were not involved. Under the 1972 version of section 9-306(4)(d), (1) above is elimi­ nated. The security interest is limited to assets in which cash proceeds have been commingled, but (2) above remains. The extent of the secured 1978] The Secured Party’s Rights in a Debtor’s Bank Account 83 party’s claim is not reduced through application of the lowest inter­ mediate balance rule. In fact, contrary to the 1962 version the amount of the secured party’s claim (as previously observed) can include cash proceeds received by the debtor within the final ten days, though some of these proceeds were never commingled. The above analysis assumes, of course, that the secured party has a recognized right in the debtor’s bank account where insolvency proceed­ ings are not involved. If, on the other hand, a court should hold that the security interest is discontinued upon commingling except in situations covered by section 9-306(4)(d), it confers additional rights in all cases to which it applies.

B. Section 67c Section 67c invalidates as against the trustee in bankruptcy “ every statutory lien which first becomes effective upon the insolvency of the debtor, or upon distribution or liquidation of his property, or upon execution against his property levied at the instance of one other than the lienor.’’* 41 Does section 9-306(4)(d) provide for an invalid statutory lien? To the extent that section 9-306(4)(d) gives rights that “ may not be asserted independently of a general distribution,” there is a fair argument that it does run afoul of section 67c, unless the definition of “ statutory lien” in section l(29a) of the Bankruptcy Act saves it: Statutory lien shall mean a lien arising solely by force of statute upon specified circumstances or conditions but shall not include any lien provided by or dependent upon an agreement to give security, whether or not such lien is also provided by or dependent upon statute and whether or not the agreement or lien is made fully effective by statute.42 The rights given the secured party by section 9-306(4)(d) depend on the existence of an enforceable security agreement, perfection, and the

the effect of which transfer will be to enable such creditor to obtain a greater percentage of his debt than some other creditor of the same class. Section 60b provides: “ Any such preference may be avoided by the trustee if the creditor receiving it or benefited thereby or his agent with reference thereto has, at the time when the transfer is made, reasonable cause to believe that the donor is insolvent." For more detailed treatment, see Skilton, Security Interests in After-Acquired Property Under the Uniform Commercial Code, 1974 Wts. L. Rev. 925 , 958. The proposed new Bankruptcy Act (H.R. 8200, S. 2266, 95th Cong., 1st Sess. (1978)) would in general eliminate the requirement that the trustee prove the transferee had reason to believe that the transferor was insolvent. See § 547(b). 41. 11 U.S.C. § IO7c(l)(A). 42. 11 U.S.C. § 1 (29a). See S. Rep. N o. 1159, 89th Cong., 1st Sess. 5, reprinted in [1966] U.S. Code Cong. & A d. N ews 2456, 2460: The definition is directed at preventing a recurrence of the misapplication which appeared in the first decision in The Quaker City case. [Zzi re Quaker City 84 Southern Illinois University Law Journal [1978:60 receipt by the debtor of cash proceeds; thus, arguably, they do not arise “ solely by force of statute.” It is possible, therefore, to conclude that the rights given the secured party under section 9-306(4)(d) are not a “ statu­ tory lien” within the meaning of section 67c of the Bankruptcy Act. However, the declared purpose of the restrictive definition of “ statutory lien” in section 1 (29a) of the Bankruptcy Act was to repudiate the first decision in In re Quaker City Uniform Company,43 where it was held that the lien of a chattel mortgage was an invalid statutory lien. It depended upon the Pennsylvania Chattel Mortgage Act for its validity against adverse third party claims (such transaction being defective at common law in Pennsylvania).44 In view of this legislative history, it seems clear that section 67c is not intended to oppose consensual security interests which are statutory innovations. But the question remains whether the definition of “ statutory lien” should be construed to immunize legisla­ tively provided appendages to consensually created security interests, such as section 9-306(4)(d). The questions posed by section 64 and section 67c of the Bankrupt­ cy Act tend to merge. While as far as known no reported case has passed upon the question of the validity of section 9-306(4)(d) vis-a-vis sections 64 and 67c,45 there is, in my opinion, as a practical matter little chance that these sections of the Bankruptcy Act will be held to obstruct section 9-306(4)(d). Chances of invalidation would seem dimmer than dim if the court accepted the view that where section 9-306(4)(d) did not apply, a secured party could establish a proceeds security interest in a commingl­ ed fund if he could satisfy the requirements of tracing. With this view

Uniform Company, 2 F.2d 155 (3d Cir. 1956)]. There the court held that since the chattel mortgage depended upon the Pennsylvania recording statute for its effec­ tiveness against subsequent transferees, the chattel mortgage was a statutory lien. 43. Bankr. L. Rep. 1158.778 (1956). The decision which the House Report refers to is the first decision In re Quaker City Uniform Co. wherein the court held that a chattel mortgage was a statutory lien; this opinion is not officially reported and was withdrawn by the court. In a subsequent decision, the court reached the same result as in the first decision, but, on the point in question, assumed without deciding that the chattel mort­ gage was a consensual lien. Interestingly enough the court cited In re Tele-Tone Radio Corp., 133 F. Supp. 739 (D.N.J. 1955) which correctly held that a factor’s lien was a consensual lien and not a statutory one. The difficulty arose because many forms of consensual liens are regulated by statute in terms of the acquired writing, perfection and procedures on default. Nevertheless, the lien itself is created by the agreement between the parties and is not created by a statute in the absence of agreement. 1 Collier on Bankruptcy § 129a at 130.27 (14th ed. 1974). 44. Maynard v. Shaw, 246 Pa. 330, 92 A. 204 (1914); Clow v. Woods, 5 Serg. & Rawl. 275 (Pa. 1819). 45. There has been considerable litigation with respect to the interpretation and validity of § 2-702(2) (seller’s reclamation rights) in bankruptcy. It is questionable whether such cases have any relevance to § 9-306(4)(d) problems. In Federal's Inc. v. Matsushita 1978] The Secured Party’s Rights in a Debtor’s Bank Account 85 modifications of section 9-306(4)(d)’s tracing rules could be viewed as unobjectionable applications of a relaxed substitution theory, whose potential benefit to the secured party is offset by the ten day limit.

C. Section 60 Under defined conditions, section 60 of the Bankruptcy Act permits the trustee in bankruptcy to set aside preferential transfers made by the bankrupt to a creditor within four months prior to the filing of the petition in bankruptcy. The creation of a security interest as well as a transfer to a creditor in the form of a payment may come within the bounds of section 60. To the extent that section 9-306(4)(d) is construed to give additional rights to the secured party in the debtor’s assets, the question of a

Electric Corp., 553 F.2d 509 (6th Cir. 1977) the court sustained application of § 2-702(2) against the trustee in bankruptcy's claim of invalidity under §§ 64 and 67c(l)(A). The opinion concedes that § 2-702(2) "is more than a mere codification of common law ," since in Michigan, prior to the Code, rescission was allowed for fraud "only in cases of intentional misrepresentation and receipt of goods by an insolvent without the intention to pay for them ." Nevertheless, § 2-702(2) did not provide for a statutory lien invalid under § 67c. “ Because that right conceptually has its antecedents in the historical and equitable right of a defrauded seller to reclaim the goods he has sold to an insolvent buyer, we hold it cannot be said to arise 'solely by force of statute’ under § l-(29a)." The court also held that § 64 did not stand in the way. A similarly indulgent attitude could sustain applications of § 9-306(4)(d) from attack under §§ 64 and 67c. The current provisions of the proposed new Bankruptcy Act would not seem to alter the discussion significantly. Section 545 of S.2266 and also of H.R.8200, 95th Cong., 1st Sess. (1977) would provide: § 545. Statutory liens The trustee may avoid the fixing of a statutory lien on property of the debtor that— (1) first becomes effective against the debtor— (A) when a case under this title concerning the debtor is commenced; (B) when an insolvency proceeding other than under this title concerning the debtor is initiated; (C) when a custodian is appointed or takes possession; (D) when the debtor becomes insolvent; (E) when the debtor’s financial condition fails to meet a specified standard; or (F) at the time of an execution against property of the debtor levied at the instance of an entity other than the holder of such statutory lien; (2) is not perfected or enforceable on the date of the filing of the petition against a bona fide purchaser that purchases such property on the date of the filing of the petition, whether or not such a purchaser exists; (3) is for rent; or (4) is a lien of distress for rent.

Section 101 (H.R.8200) provides: (35) “ security agreement" means agreement that creates or provides for a security interest; (36) “ security interest" means lien created by an agreement; (37) “ statutory lien" means lien arising solely by force of a statute on specified circumstances or conditions, or lien of distress for rent, whether or not statutory, but does not include security interest or judicial lien, whether or not such interest or lien is provided by or is dependent on a statute and whether or not such interest or lien is made fully effective by statute: The definitions of “ statutory lien" and "security interest" in § 101 (H.R.8200) in my opinion leave open the question whether any special rights created by § 9-306(4)(d) are 86 Southern Illinois University Law Journal [1978:60 preferential transfer arises. Perhaps judicial gymnastics like those in DuBay v. Williams46 can be employed to save such additional rights from the taint of preference, by dating the “ transfer” back to the time of filing a financing statement (how metaphysical can one get?), or by concluding that the additional rights derive “ new value” via section 9- 108 or through a relaxed substitution view47 (how indulgent can one get?). Here, however, we are not dealing with the case of property acquired by the debtor in the last four months to which a security interest automatically attaches under an after-acquired property clause in a secu­ rity agreement, but with a separate subject—the operation of section 9- 306(4)(d) to give the secured party additional rights to a share of the debtor’s funds in the event of insolvency proceedings. To argue from the after-acquired property clause case to this asks a court to take a long extra step at the expense of unsecured creditors. The additional step a court must take to approve is that a right in a debtor’s general bank account which is activated only in the event of insolvency proceedings and cannot be claimed before insolvency pro­ ceedings should be treated much as if there was an effective after- acquired clause automatically attaching the security interest to property subsequently acquired by the debtor. Theories that might make sense in the after-acquired property clause case could sound hollow here. To the extent that section 9-306(4)(d) is construed to give additional rights to the secured party that he would not otherwise have, it seems like the English floating charge, which, nebulous, inchoate, a mere contin­ gency, floats like a cloud above until triggered by insolvency proceed­ ings it rains down. Nevertheless, keeping in mind that the ten-day limit of section 9- 306(4)(d) may be viewed as a trade-off for the relaxation of tracing requirements, it is likely that a court which would reject challenge under sections 64 and 67c of the Bankruptcy Act would also find that the section 9-306(4)(d) “ perfected security interest” was not vulnerable under section 60. But if, contrary to what seems the clear trend of authority, a court decides that save for the situation covered by section 9-306(4)(d), the secured party has no rights in a debtor’s bank account in which cash

“ created by agreement” or instead “ arise solely by force of a statute." Priorities would be dealt with by § 507 of S.2266 and H.R. 8200. The question whether applications of § 9- 306(4)(d) would constitute an invalid interference with the federal plan of distribution o f an insolvent's estate would seem to remain basicatly the same as under present § 64. 46. 417 F.2d 1277, 6 U.C.C. Rep. 885 (9th Cir. 1969). 47. See Grain Merchants of Indiana, Inc. v. Union Bank & Savings Co , 408 F.2d 209, 6 U.C.C. Rep. 1 (7th Cir. 1969), cert, denied 396 U.S. 827 (1969). Conflicting decisions as to the validity of section 10(b) UTRA under the Bankruptcy Act are not very persuasive. 1978] The Secured Party’s Rights in a Debtor’s Bank Account 87 proceeds have been commingled (because they cease to be identifiable) it would seem to follow that any rights recognized by section 9-306(4)(d) are additional rights, and fair game for section 60 attack. The Ninth Circuit,48 however, in the only reported decision, as far as known, dealing with the validity of section 9-306(4)(d) under the Bankruptcy Act, curiously held that rights conferred by section 9-306(4)(d) were nonpreferential to the amount of cash proceeds subject to the security interest deposited in the debtor’s bank account in the final ten days, although the opinion indicated that outside of Section 9-306(4)(d) the secured party had no security interest in the debtor’s bank account .49 The logic escapes me. Speaking to the larger concerns of public policy, we must keep in mind that when a debtor becomes insolvent, unsecured creditors catch few enough crumbs as it is from the secured party’s table. To invade this small amount by depleting the debtor’s liquid assets in his cash and bank account, that is, any part thereof which may not through tracing be shown to be the secured party’s contribution, can be at the expense of unsecured creditors, particularly creditors high in the order of priority of distribution under section 64, and also at the expense of the proper administration of the bankrupt’s estate.50 If according to state law the security interest exists only in the event of insolvency proceedings, fairness and legality cannot be taken for granted.

D. Section 60: Payments to the Secured Party from the Debtor’s Bank Account

(a) Payments in the Final Ten Days Section 9-306(4)(d) provides that the secured party’s claim on the amount present in the debtor’s bank account at the time of the institution because of the important differences between the provisions of § 10(b) UTRA and § 9- 306(4)(d). See In re Crosstown Motors, Inc., 272 F.2d 224 (7th Cir. 1959); In re Harpeth Motors, Inc., 135 F. Supp. 863 (M.D. Tenn. 1955); 2 Gilmore, Security Interests in Personal Property, 1340-44 (1965). 48. Arizona Wholesale Supply Co. v. Itule (In re Gibson Products) 543 F.2d 652 (9th Cir. 1976). 49. As previously noted, the Ninth Circuit decision involving section 60 was oc­ casioned by its erroneous construction of the term “ cash proceeds” in § 9-306(4)(d) to include cash deposits not subject to a proceeds security interest under § 9-306(1). While the secured party’s rights were reduced via § 60 to the amount of § 9-306(1) cash proceeds traceable into the account, there is no indication that the court would have imposed the lowest intermediate balance rule as a further limitation on the operation of § 9-306(4)(d). 50. Section 547 of the proposed new Bankruptcy Act (S. 2266 and H.R. 8200, 95th Cong., 1st Sess. (1977)) would radically change the preference rules now contained in § 60. See generally, Queenan, The Preference Provisions o f the Pending Bankruptcy Law, 82 88 Southern Illinois University Law Journal [1978:60 of insolvency proceedings is to be reduced by the sum of payments made from the fund to the secured party during the immediately preceding ten days. Suppose it appears that the sum of such payments to the secured party during the final ten days is greater than the amount of cash proceeds subject to the security interest received by the debtor during the ten days? May the debtor’s trustee in bankruptcy invoke section 60 in an effort to recover the excess?

Com . L.J. 465 (1977). How such provisions would affect the question of the validity of applications of § 9-306(4)(d) in bankruptcy is difficult to assess. (Let us suppose that § 9- 306(4)(d) rights are not an invalid statutory lien or invalid priority.) In general, the acquisition of a proceeds security interest as a result of the disposition of collateral subject to a perfected security interest would seem to qualify as a protected transfer for “ new value” under § 547(c)(3), at least to the extent of the value of original collateral, if the secured party's rights in the original collateral could not be avoided by the trustee. Section 547(c)(3) would provide: The trustee may not avoid under this section a transfer (I) To the extent that such transfer was— (A) intended by the debtor and the creditor to or for whose benefit such transfer was made to be a contemporaneous exchange for new value given to the debtor: and (B) in fact a substantially contemporaneous exchange . . . As applied to § 9-306(4)(d) problems: it seems reasonable to conclude that any rights provided in the debtor’s bank account in the final ten days would usually qualify, as being an intended contemporaneous exchange for the release of the original collateral, and “ in fact . . . substantially contemporaneous,” despite modest relaxation of tracing rules, provided it is held that § 9-306(4)(d) merely modifies, in insolvency proceedings, a secured party’s normal claim to a proceeds security interest in a debtor's bank account. However, it it is held that a secured party has no proceeds security interest in funds deposited in a debtor’s bank account except as provided by § 9-306(4)(d) it becomes analytically more difficult to protect the § 9-306(4)(d) situation under subsection (c)(3). If in a given case subsection (c) would not aid the secured party, he may be protected by subsection 547(c)(5). Subsection (c)(5) of H.R.8200 (95th Cong., 1st Sess. (1977)) would provide: The trustee may not avoid under this section a transfer. (5) of a perfected security interest in inventory or a receivable or the proceeds of either, except to the extent that the aggregate of all such transfers to the transferee caused a reduction, as o f the date of the filing of the petition and to the prejudice of other creditors holding unsecured claims, of any amount by which the debt secured by such security interest exceeded the value o f all security interests for such debt on the later of: (A) 90 days before the date o f the filing of the petition; and (B) the date on which new value was first given under the security agree­ ment creating such security interest . . . Thus, the debtor might in the last ninety days, acquire "inventory” or “ receivables" (as defined) which when acquired would become subject to a security interest by virtue of an after-acquired property clause in a security agreement. Assume that such security interest would not be supported by new value so as to qualify under § 547(c)(3). The secured party’s rights in this after-acquired collateral would be subject to the no im­ provement, two-part test of § 547(c)(5). The two-part test would apply to the aggregate collateral, including proceeds, determined at the beginning and at the end o f the ninety day period. The amount of the secured party’s rights in proceeds from the sale or collection of the original collateral (inventory and/or receivables) would be included in the calculations. If a court held that a secured party had no proceeds rights in a debtor’s bank account except those provided in § 9-306(4)(d), the secured party’s security position at the begin- 1978] The Secured Party’s Rights in a Debtor’s Bank Account 89

In Fitzpatrick v. Philco Finance Corp. ,51 the debtor had received $4,513.44 as cash proceeds in the final ten days, and during this time the secured party had received $44,766.84 from the debtor’s bank account. The Seventh Circuit permitted the trustee in bankruptcy to recover payments made during the final ten days to the secured party by the debtor from his bank account in excess of cash proceeds deposited in the final ten days even though by applying normal tracing procedures the secured party could attribute those payments to prior deposits of cash proceeds in which he had a perfected security interest. The trustee’s vehicle was section 60 of the Bankruptcy Act and he was able to establish the elements of voidable preference. The reason for the holding was that the secured party received more than he was entitled to under section 9- 306(4)(d) and the rights given by section 9-306(4)(d) (1962) were exclu­ sive, in the event of insolvency proceedings. Section 9-306(4)(d), it should be noted, does not explicitly provide for recovery of excess payments; its reference to payments made to the secured party in the final ten days is to provide that they are deductible from the amount of the secured party’s claim. But recognition of a right to recover excess payments may not be an unreasonable inference from section 9-306(4)(d). Still, one wonders. Wonder approaches bewilderment when we focus on the treatment of $5,206.30 in checks drawn on the account by the debtor and received by the secured party and deposited twelve days before the institution of insolvency proceedings, which were held to be payments to the secured party within the ten day period. It was four days later (within the ten day period) that the drawee bank paid. The secured party would have been better off if it had not depended upon normal collection channels, but had personally presented the checks for payment on the day received. The line must be drawn somewhere but does this line drawing make sense? What if this $5,205.30—or any other part of the payments to the secured party found to have been made in the last ten days—had been on account of cash proceeds consisting of checks received by the debtor shortly ning of the ninety day period would not include rights in proceeds deposited in the debtor's bank account; but would include rights in the bank account (if any exist) at the end of the period. Thus, there would be more chance that a forbidden improvement would be found than if a court held that § 9-306(4)(d) was simply a modification of the secured party’s normal rights based on tracing, in a debtor's bank account containing commingled proceeds. A last minute note as o f publication: The House passed by a voice vote on February 1, 1978, H.R. 8200 (95th Cong., 2d Sess. (1978)), which, 1 understand, as to matters dis­ cussed above is like the first session’s bill. S.B. 2226 (95th Cong., 2d Sess. (1978)) is awaiting Senate approval. If passed, the two bills will go to a joint committee, since there are differences. 51. 491 F.2d 1288, 14 U.C.C. Rep. 12 (7th Cir. 1974). 90 Southern Illinois University Law Journal [1978:60 before, deposited in the debtor’s bank account, and sent to the secured party as soon as the items had been collected, and the debtor had a right to draw? Assume all payments to the secured party were made within ten days after receipt of proceeds by the debtor. Should not such payments to the secured party, so timely made by the debtor, be protected? If section 9-306(4)(d) gives the secured party rights in the debtor’s receipt of cash proceeds for the last ten days, why should not any payments made on account of the debtor’s receipt of cash proceeds be similarly protected, if within ten days from start to finish? Section 9-306(4)(d) is silent as to recovery of excess payments during the final ten days, perhaps with good reason.52

(b) Payments Before Final Ten Days The attorney for the trustee in bankruptcy in the Fitzpatrick case limited his claim to such payments from the commingled bank account as had been made to the secured party in the final ten days. Was he right? I believe he was. He was right if we accept the view that the secured party with a perfected security interest in original collateral may by tracing establish his security interest in the debtor’s bank account to the extent that cash proceeds from the sale or collection of collateral are there deposited by the debtor; and that the operation of section 9-306(4)(d) is limited to transactions in the last ten days involving transfers out of the account. If, prior to the final ten days, the secured party has received payments from the debtor from a commingled bank account in which the secured party has a perfected security interest to the extent of the payments, no preferential transfer takes place, since the transfer did not put the secured party in a better position vis-a-vis unsecured creditors. There may be some circular reasoning involved here, since if payment had not been made, the secured party would have lost all claim to such deposits, in view of section 9-306(4)(d). A contrary view, however, would open up all payments made from a commingled bank account within four months of the eventual date of the filing of a petition in bankruptcy, and subject

52. Note that a check consisting of cash proceeds might be received by the debtor twelve days before the institution of bankruptcy proceedings, but not finally paid by the drawee bank until four days later. Here, it would be to the advantage of the secured party to hold that the cash proceeds were not received by the debtor at the time the check was received, but only subsequently at the time the check was paid. Whereas in the Fitzpatrick case, it would have been to the advantage of the secured party to hold that he had received payment by check from the debtor's bank account at the time of receipt of the check, rather than when the check was finally paid. While it may seem just to calculate the minuend and the subtrahend by treating uncollected checks the same way for both purposes, the language of § 9-306(4)(d) presents difficulties. Thus, the minuend is limited to "an amount not greater than the amount of any cash proceeds received by the debtor 1978] The Secured Party’s Rights in a Debtor’s Bank Account 91 such payments to section 60 attack, the same as if they had not derived from cash proceeds. Surely the draftsmen of section 9-306(4)(d) did not intend such disruptive result, and there seems no need to construe Section 60 of the Bankruptcy Act to require it. If, however, a court takes the view that the only rights in a debtor’s bank account containing commingled cash proceeds are those conferred by section 9-306(4)(d), limited to receipts and deposits in the final ten days, the case assumes a different posture. Payments to the secured party prior thereto are payments from an unsecured source, and the section 60 battle may be fairly waged by the trustee in bankruptcy. It was perhaps under the impression that the 1952 version of Section 9-306 recognized no secured party rights in the debtor’s bank account except for the situation covered by the 1952 version of section 9-306(4)(d) that the court in Howarth v. Universal CIT Credit Corp.53 expressed the view that prior payments could be recovered by the trustee in bankruptcy by proving a case under section 60 of the Bankruptcy Act. That was an early case, however, and it is doubtful that such view will be followed today.

VI. In Sum A great deal of scholarly attention has been devoted to arguments pro and con as to the validity of section 9-306(4)(d) under the Bankruptcy Act.54 Much of these labors would come under the heading of overexer­ tion if section 9-306(4)(d) is viewed as a qualification, sometimes unfa­ vorable to the secured party, of rights in commingled funds normally available under Article 9. In any event, however, the presence of section 9-306(4)(d) continues to raise some legitimate bankruptcy questions. Thus, in addition to complicating the administration of a bankrupt’s estate by its complicated formula, section 9-306(4)(d) invites trouble in raising bankruptcy legality questions. All could be forgiven, however, if there were a logical purpose to section 9-306(4)(d)—but is there?

within ten days." Checks are "cash proceeds" according to § 9-306(1). Presumably this means that cash proceeds are received when the debtor receives an uncollected check. Still, it would be possible to hold that upon collection, another receipt takes place. The subtrahend, on the other hand, is to be determined by taking into account "payments” made to the secured party in the final ten days, and it is a simple matter to hold, as the court did in Fitzpatrick, that payment is accomplished only when a check used as the medium of payment is collected. 53. 203 F. Supp. 279, I U.C.C. Rep. 515 (W.D. Pa. 1962). 54. I have not discussed § 9-306(4)(d) versus § 70c of the Bankruptcy Act. The question of the validity of § 9-306(4)(d) under the Bankruptcy Act has evoked numerous discussions—perhaps out of proportion to the financial importance of the topic. See, e.g., 2 G. Gilmore, Security I nterests in Personal Property, 1348 (1965); Countryman, Code Security Interests in Bankruptcy, 75 Com . L.J. 269 (1970); Epstein, "Proceeding” Under the Uniform Commerical Code, 30 Ohio St . L.J. 787 (1970); Henson, Proceeds 92 Southern Illinois University Law Journal [1978:60

A. The Philosophy of Section 9-306(4)(d) One difficulty in resolving the section 60 preference question with respect to payments made to the secured party from a commingled fund at some time prior to the final ten days preceding the institution of insolvency proceedings stems from the fact that section 9-306(4) applies “ in the event of insolvency proceedings,” and insolvency proceeding litigation seems to be involved when a trustee in bankruptcy makes claim against a secured party under section 60b. And yet surely, it would seem, the draftsmen of section 9-306(4)(d) did not intend the drastic roll-back effect which would ensue if their words were interpreted to cast a shadow over payment transactions from a commingled fund that had taken place prior to the final ten days. In this situation, the strongest case for roll-back under section 60 of the Bankruptcy Act is presented if section 9-306(4)(d) is held to be the only basis for a secured party claimant’s rights in a commingled fund. If so, no security interest would attach to and be perfected in a debtor’s bank account containing cash proceeds as to any deposits made prior to the final ten days, and payments from the account would be from an unprotected source. But if this view is adopted, the draftsmen have created an entirely unreasonable provision. If the raison d ’etre for the ten day limitation of section 9-306(4)(d) is to persuade the secured party to careful policing of the debtor’s receipts of cash proceeds and to reward the diligent and punish the lax,55 consistency requires that an equally diligent secured party be equally treated, whether or not transactions were followed by an insolvency proceeding. The preference could, of course, have been avoided if the debtor had remitted the cash proceeds directly to the secured party, or deposited them in a separate account, and then paid by check drawn on that account. If, on the other hand, it is held that in situations not covered by section 9-306(4)(d) the security interest continues as to traceable cash proceeds in the debtor’s bank account, and derives its perfection from a duly filed financing statement, the trustee in bankruptcy’s claim under section 60 should collapse.

B. Section 9-306(4)(d)— A Carrot and a Stick While the application of section 9-306(4)(d) is confined to insolven­ cy proceedings, this is no small matter. The debtor’s bankruptcy poses

Under the Uniform Commerical Code, 65 Co lum . L. Rev. 232 (1967); Kennedy. The Trustee in Bankruptcy Under the Uniform Commerical Code: Some Problems Suggested by Articles 2 and 9, 14 Rutgers L. Rev. 578 (1960); Murphy and Peitzman, Without a Trace: The Secured Creditor's Interest in Deposit Account Proceeds, 49 Bankr. L.J., 303 (1975); Marsh, Book Review, 13 U.C.L.A. L. Rev. 898, 907-08. 55. See 2 Gilmore, Security I nterests in Personal Property 1340 (1965). 1978] The Secured Party’s Rights in a Debtor’s Bank Account 93 the biggest single threat to the integrity of a secured transaction. Secured parties had better guard against this possibility above all. Thus section 9-306(4)(d) has the effect of a carrot or a stick. As a carrot, the section induces the secured party to adopt careful policing practices and to insist that the debtor remit within ten days of receipt all cash proceeds deposited in his bank account. As to unremitted cash proceeds so deposited, a special claim is accorded under section 9- 306(4)(d). As a stick, section 9-306(4)(d) penalizes lax practices by denying a claim on the debtor’s bank account, as to cash proceeds deposited in the debtor’s bank account received by the debtor more than ten days prior to the institution of insolvency proceedings. Section 9-306(4)(d) is however a rather crude carrot and stick, suffering from inconsistency and the potential of injustice. The best policing would be to require the debtor to remit all cash proceeds directly, or at least to require the debtor to deposit them in a separate account. But even a diligent secured party, conscious of the strictures of section 9-306(4)(d), may not be able to control the situation. Such strict policing practices cannot always prevent a debtor from suddenly turning untrustworthy and departing from authorization and depositing cash proceeds in his general bank account rather than a special bank account or remitting them intact to the secured party. The ten days of section 9- 306(4)(d) begins to run from the time of receipt and not from the time the secured party learns of the fact. And suppose through extreme diligence or luck the secured party within ten days discovers what has happened and demands payment from the debtor? The cooperation, demanded but not always forthcoming, must be consummated with great dispatch, otherwise the ten days will have run, in case of subsequent insolvency proceedings. And if a more permissive secured party allows the debtor to deposit cash proceeds in his (the debtor’s) general bank account, on the condition that all proceeds so deposited be remitted within ten days, a debtor turned suddenly untrustworthy may, in violation of understanding, fail to pay the secured party.

C. The Uniform Trust Receipts Act The predecessor and it would seem the chief inspiration of section 9- 306 as a whole, and section 9-306(4)(d) in particular, was section 10 of the Uniform Trust Receipts Act.56 While section 10 of UTRA had certain defects, these were not in basic consistency.

56. 9(c) U .L.A . 231 (Miscellaneous Acts, 1957). It should be recalled that the advan­ tages accorded by UTRA required " A Trust Receipt Transaction." The standard version of UTRA required that new value be given by a lender to enable the dealer to acquire the collateral. Promulgated in 1933, the design of UTRA to give encouragement to new 94 Southern Illinois University Law Journal [1978:60

1. Section 10(c) gave rights in “ identifiable” proceeds irrespec­ tive of whether insolvency proceedings were involved. “ Identifiable” was not defined; there was no suggestion that commingling of cash proceeds by the debtor resulted in loss of identification. 2. In keeping with an insistence on the policing of proceeds, under section 10 proceeds rights were accorded an “ entruster” giving “ liberty of sale” to the trustee only where the trustee “ is to account to the entruster for the proceeds of any disposition.” (UTRA had no equivalent of U.C.C. section 9-205.)57 58 Further, rights accorded by key subsection (c) could be lost if the entruster waived such rights “ by words or conduct; and knowledge by the entruster of the existence of proceeds, without demand for accounting made within ten days from such knowl­ edge, shall be deemed a waiver.” This insistence on policing was in basic accord with Benedict v. Ratner,56 subject to some statutory modifi­ cation. 3. Rights in addition to those recognized in section 10(a) and (c) of UTRA, were accorded by section 10(b), which is the immediate ancestor of section 9-306(4)(d). The entruster was entitled To any proceeds or the value of any proceeds (whether such proceeds are identifiable or not) of the goods, documents or instruments, if said proceeds were received by the trustee within ten days prior to either application for appointment of a receiver of the trustee, or the filing of a petition in bankruptcy or judicial insolvency proceedings by or against the trustee, or demand made by the entruster for a prompt accounting, and to a priority to the amount of such proceeds or value . . . ,59 Where applicable, section 10(b) rights attached to all of the debtor’s estate. Its extensive reach for assets could be justified only on the controversial assumption that if proceeds subject to a trust receipt securi­ ty interest were received within 10 days they remained in some form and financing might have been viewed as a counter-depression measure so that 10(b) deserved support in its time as a stimulant to new business. 57. Section 9-205 provides: A security interest is not invalid or fraudulent against creditors by reason of liberty in the debtor to use, commingled or dispose of all or part of the collateral (including returned or repossessed goods) or to collect or compromise accounts or chattel paper, or to accept the return of goods or make repossessions, or to use, commingle or dispose of proceeds, or by reason of the failure of the secured party to require the debtor to account for proceeds or replace collateral. This section does not relax the requirements of possession where perfection o f a security interest depends upon possession of the collateral by the secured party or by a bailee. 58. 268 U.S. 353 (1925). 59. Uniform Trust Receipts Act, § 10(b). Stillborn, § 9-306(3) (1955) would have matched § 10(b) UTRA in the extent of its claim on general assets, in the event of insolvency proceedings. 1978] The Secured Party’s Rights in a Debtor’s Bank Account 95

added to the net worth of the debtor, at least for a period of ten days, rather than being dissipated or used to pay off other obligations. Compared with this, the grasp of section 9-306(4)(d) is modest indeed. What is of principal interest, however, is that section 10(b) applied fair weather or foul; its benefits to the secured party were not confined to insolvency proceedings. On the contrary, in any case where the entruster made demand for a prompt accounting, he was given additional rights not dependent on tracing in the general assets of the debtor, to the extent of the value of proceeds received by the debtor in the last ten days. Unlike section 10(c), the ten days of section 10(b) did not begin to run only from the time that the entruster had knowledge of the receipt. The intervention of insolvency proceedings was simply made the equivalent of “ demand made for a prompt accounting.” As far as I know, the only reported decisions under section 10(b) UTRA involved the entruster’s assertion of rights in the trustee’s general assets, with no tracing involved.60 I know of no case which held that an entruster who could trace cash proceeds into a commingled fund, could not claim rights under section 10(c), on the ground that such proceeds ceased to be “ identifiable.” The logic of the Uniform Trust Receipts Act was lost when the rule of section 9-306(4)(d) was confined to insolvency proceedings. If the raison d ’etre was to encourage policing and the threat was loss of right through waiver, whatever benefits section 9-306(4)(d) bestowed should have applied pari passu, as in UTRA 10(b), to non-insolvency proceed­ ing situations, with the trigger to determine the ten days something like “ demand made for a prompt accounting.”

VII. Section 2-702(2) A special rule limited to insolvency proceedings is what is wrong with section 9-306(4)(d). What is wrong with section 9-306(4)(d) may be further demonstrated by comparing it with section 2-702(2) of the U.C.C. which concerns a seller’s right to reclamation of goods sold on credit to an insolvent buyer. (1) Section 2-702(2) provides that a seller of goods on credit has reclamation rights if he makes demand within ten days after receipt of the goods by an insolvent buyer. The seller’s ten-day right does not arise solely upon the event of insolvency proceedings. (2) The ten-day right is not exclusive in any case where the seller

60. See, e.g., In re Crosstown Motors, Inc., 272 F.2d 224 (7th Cir. 1960); In re Harpeth Motors, Inc., 135 F. Supp. 863 (M.D. Tenn. 1955); Commerce Union Bank v. Alexander, 44 Tenn. App. 104, 312 S.W.2d 611 (1957); Universal C.I.T. Credit Corpora­ tion v. Thursday Chevrolet Co., 136 So. 2d 15 (Ct. App. Fla. 1962). 96 Southern Illinois University Law Journal [1978:60 can show justifiable reliance upon a written representation of solvency made by the buyer within three months prior to delivery of the goods.61 Situation (1) is analogous to secured partys’ rights in nontraceable assets under section 9-306(4)(d). Situation (2) is analogous to secured partys’ rights in traceable proceeds, which are preserved by section 9- 306(4)(a), (b) and (c) but limited by section 9-306(4)(d) where insolven­ cy proceedings are involved. The scheme of section 2-702(2) is logical enough,62 and shows the same pattern of analysis as section 10 of UTRA. This is not surprising, since they are apparently the work of the same author.63

VIII. Conclusion Section 9-306(4)(d) loses vital purpose if a court holds that a secured party has rights in commingled funds, containing cash proceeds, where insolvency proceedings are not involved, dependent upon tracing: 1. In most cases, it may be guessed, where application of section 9-306(4)(d) changes the result which would be achieved by application of a rule based on tracing, it serves to cut down the secured party’s rights, by placing a limit on the secured party’s claim on commingled funds to receipts of cash proceeds in the last ten days, even when the secured party could trace. 2. In the cases where it adds to the secured party’s rights by eliminating some tracing requirements, it inconsistently distorts the law by creating a special rule for insolvency proceedings. 3. From the secured party’s point of view, it is questionable whether extra benefits sometimes given are a sufficient trade-off for normal rights sometimes lost. In any event, section 9-306(4)(d) loses all sense of justice when

61. Applying the normal rules applicable to rescission based on misrepresentation, presumably the seller would suffer loss of right if he failed to take action to rescind within a reasonable time after receipt of such knowledge or notice of the falsity of buyer’s representation. 62. On the other hand, I am unable to say the same for § 2-502, which deals with the converse case—buyer's rights to recover goods on seller’s insolvency—where the buyer has paid a portion of the purchase price on identified but undelivered goods. Here, by tendering the balance o f the purchase price, the buyer may “ recover them from the seller if the seller becomes insolvent within ten days after receipt of the first installment on their price” . Literally construed, this section deserves to be placed in the category of “ the humor of the Uniform Commercial Code." It seems seller’s insolvency must occur in the ten day interval after buyer’s payment. So if seller is insolvent at the time buyer pays, buyer has no rights under § 2-502. On the assumption that the draftsmen did not intend to stultify themselves, I would have a court reword § 2-502 to read “ if the seller was or becomes insolvent within ten days after receipt.” 63. Karl N. Llewellyn, 1893-1962. 1978] The Secured Party’s Rights in a Debtor’s Bank Account 97 applied to cases where the debtor has wrongfully sold the collateral and deposited the funds in his own bank account, without knowledge of the secured party. Was it intended to limit the secured party’s rights in such case? If so, is the injustice sufficient to raise a constitutional question? Obviously, the shortcomings and pitfalls of section 9-306(4)(d) should persuade secured parties to insist that the debtor remit cash proceeds intact or deposit them in a special bank account. Finally, though no subsection of Article 9 has borne evidence of more labored draftsmanship than section 9-306(4)(d), having undergone successive drastic changes from 1952, in the 1962 and 1972 versions, (all for the purpose of “ clarification” ?) it seems that as an end product, the draftsmen have labored and given birth to a malformed mouse, and instincts of mercy to all concerned should recommend that it be dispens­ ed with or entirely reshaped. On the positive side, section 9-306 (as well as the rest of the Code) should be reexamined to make it clear what rights, fair weather and foul, insolvency proceedings or no insolvency proceedings, a secured party should have in cash proceeds deposited by the debtor in his general bank account. The underlying purpose of the Uniform Commercial Code should be to “ simplify, clarify and moder­ nize the law governing commercial transactions.” 64

Darryl Pratscher

64. Section l-102(2)(a) (emphasis added).