UCC Article 9-205 Analysis and Commentary: Use or Disposition of Collateral is Permissible (Floating Lien)

1. Introduction to UCC Article 9-205

UCC Article 9-205 is a provision in the Uniform Commercial Code (UCC) that governs security interests in personal property, providing a standardised framework for lenders and borrowers in commercial finance.

UCC 9-205, titled “Use or Disposition of Collateral Permissible,” addresses the effects of a debtor’s use of collateral on the validity of a security interest. In simple terms, it clarifies that a security interest remains valid even if the debtor has the freedom to use, sell, or otherwise deal with the collateral.

This section is important because it legitimises common financing arrangements — often referred to as “floating liens” — where collateral may be in flux or continuously turning over.

2. Statutory Overview

UCC 9-205 is a relatively brief provision, but it packs important concepts. It contains two main subsections.

Subsection (a) sets out circumstances under which a security interest is “not invalid or fraudulent against creditors”. Subsection (b) provides a caveat regarding situations where possession of collateral is legally required.

2.1 Debtor’s Rights to Use Collateral

Under UCC 9-205(a)(1), a security interest is not invalid solely because the debtor has the right or ability to use, commingle, or dispose of the collateral. The statute explicitly lists several actions a debtor might take with collateral that do not undermine the security interest:

• The debtor may use the collateral in normal operations or even commingle it with other assets. For example, if the collateral is raw materials or inventory, the debtor can use or mix those materials in production or sales.

• The debtor may dispose of all or part of the collateral. Disposition includes selling the collateral or otherwise transferring it. Notably, this even covers scenarios where goods that were collateral are sold and potentially later returned or repossessed, and the debtor can accept those returns or repossess the goods without voiding the lien.

• The debtor may collect, compromise, enforce, or otherwise deal with the collateral. This part is especially relevant if the collateral is in the form of receivables, chattel paper, or other rights to payment. The debtor is free to collect payments or negotiate settlements on those obligations.

• The debtor may use or dispose of proceeds of the collateral. “Proceeds” generally means whatever is acquired upon the sale, exchange, or other disposition of the original collateral (often cash or accounts receivable). UCC 9-205 makes clear that the security interest isn’t void just because the debtor uses the money or property obtained from the collateral’s sale.

2.2 No Duty to Account for Proceeds or Replace Collateral

UCC 9-205(a)(2) adds that a security interest remains valid even if the secured party does not require the debtor to account for the proceeds or to replace the collateral.

In practice, this means the lender (secured party) is not obligated by law to track every sale or demand that any sold collateral be immediately substituted with new collateral or that the cash proceeds be segregated.

The absence of such requirements in the security agreement will not, by itself, render the security interest fraudulent or ineffective.

Essentially, the law does not force secured parties to impose restrictive controls on the debtor’s handling of collateral proceeds as a condition of maintaining a valid lien.

2.3 “Solely Because” Limitation

It is important to note the phrasing “solely because” in subsection (a). The provision protects the validity of a security interest in the face of debtor freedoms listed above, but only to the extent that those are the only factors at issue.

In other words, allowing the debtor to use or dispose of collateral does not by itself invalidate the lien. However, the security interest must still satisfy the other requirements of attachment and perfection elsewhere in Article 9.

UCC 9-205 does not fix a fundamentally deficient security interest; it simply prevents certain debtor liberties from being used as the sole reason to challenge the interest’s validity.

2.4 Possession Requirements Not Relaxed

Subsection (b) of UCC 9-205 provides an important caveat: if a security interest’s attachment, perfection, or enforcement depends on the secured party’s possession of the collateral, this section does not eliminate that requirement.

In plainer terms, UCC 9-205 does not override other rules in Article 9 that require the secured party to have possession (or control) of specific collateral types to have an effective security interest.

For example, certain collateral (like negotiable instruments, or tangible money, or sometimes goods in a possessory pledge) may need to be held by the secured creditor or its agent to perfect the interest.

If the law says possession is required for a particular security interest to attach or remain perfected, UCC 9-205 will not excuse the secured party from losing perfection by letting the debtor hold or use that item.

This subsection ensures that while debtors can have liberty with collateral in general, it doesn’t extend to situations where physical possession by the creditor is a legal condition for the lien.

The takeaway is that UCC 9-205’s permission for debtor use of collateral applies to non-possessory security arrangements, and it doesn’t change the rules for collateral that by nature must be held by the secured party.

In summary, the statutory text of UCC 9-205 establishes that a security interest (lien) in personal property remains valid even if the debtor has broad authority over the collateral and its proceeds, and even if the lender isn’t actively monitoring or replenishing the collateral, provided that all other requirements for a valid security interest are met.

The only explicit limitation is that any separate legal requirement of possession as a condition for perfection or attachment still stands.

3. Function of UCC 9-205 Within Article 9

To understand UCC 9-205’s function, it helps to see how it fits into the broader Article 9 secured transactions framework.

Article 9 of the UCC is designed as a comprehensive system governing the creation, effectiveness, perfection, and priority of security interests in personal property.

UCC 9-205 is one piece of this puzzle, sitting in Part 2 of Article 9 (which deals with the effectiveness of security agreements and attachment of security interests). Here’s how 9-205 functions within Article 9:

3.1 Complementing the Attachment and Floating Lien Concept

Article 9 allows for the concept of a floating lien, meaning a security interest can cover collateral that changes over time or is replenished.

UCC 9-204 (the immediately preceding section) explicitly permits after-acquired property clauses and future advances, so that a security interest can attach to property the debtor acquires in the future and secure new loans under an existing agreement.

UCC 9-205 works hand-in-hand with this by ensuring that the security interest isn’t lost when the originally collateralized items are used or sold.

Together, these provisions enable a creditor to maintain a continuous lien on a shifting pool of assets (for example, a rotating stock of inventory or a fluctuating accounts receivable portfolio).

While UCC Article 9-204 lets the lien reach new items or proceeds, UCC 9-205 assures that the act of the debtor using or disposing of items from that pool doesn’t void the lien.

3.2 Reinforcing Article 9’s Embrace of Non-Possessory Security Interests

Earlier in Article 9, UCC Article 9-202 states that title to collateral is generally irrelevant – meaning a creditor can have a valid security interest even though the debtor retains title and use of the goods.

UCC 9-205 reinforces this modern approach by removing the concern that a debtor’s control or use of collateral could be deemed fraudulent.

In effect, UCC 9-205 supports the notion that secured transactions under the UCC do not require the secured party to have title or physical hold of the collateral (except where other sections specifically require possession).

It confirms that Article 9 embraces non-possessory security interests, where debtors commonly keep possession and use of their assets while those assets are subject to a lien.

3.3 Interaction with Perfection and Priority Rules

The perfection of security interests (making them effective against third parties) is typically achieved by filing a financing statement or by taking possession/control, depending on the collateral type (found in Article 9, Part 3).

UCC 9-205’s role is not to dictate how to perfect but to ensure the security interest isn’t automatically considered void for lack of control by the creditor.

In practice, a typical secured transaction involves the creditor perfecting its interest by filing a UCC-1 financing statement, thereby giving public notice of the lien.

UCC 9-205 assumes such a system of notice is in place. It allows the debtor to use the collateral freely while the lien remains perfected through filing or other means, thus bridging the gap between the debtor’s operational freedom and the creditor’s interest.

It also works in tandem with UCC 9-315 (which governs the continuation of a security interest in collateral and proceeds after disposition) by conceptually allowing that collateral can be sold and the lien will follow the proceeds (or sometimes the collateral itself in buyer-not-in-the-ordinary-course situations).

However, 9-205 is more about initial validity of the arrangement rather than the post-disposition effects (those are handled by 9-315 and related priority rules).

In short, 9-205 undergirds the floating lien arrangement so that it’s legally effective from the outset, whereas other sections handle how that lien is maintained and enforced against third parties.

3.4 Ensuring Coherence in Secured Transactions Law

UCC Article 9-205 also serves to codify a clear rule that keeps secured transactions predictable. Within Article 9’s framework, UCC 9-205 removes ambiguity about a secured party’s duties.

It assures that, unless otherwise agreed, the law itself does not compel a secured creditor to micromanage the collateral.

This allows other provisions (like default and enforcement rights, covenants in the security agreement, etc.) to operate without the cloud of an argument that the entire security agreement was void due to debtor’s freedoms.

By firmly establishing validity, UCC 9-205 allows Article 9’s other provisions on enforcement (Part 6 of Article 9, which deals with default and remedies) to be invoked when needed, rather than having creditors worry that the lien might never have been valid in the first place due to the debtor’s use of collateral.

4. Key Legal Principles under UCC Article 9-205

UCC 9-205 embodies several key legal principles that define how secured transactions operate when the debtor retains use of the collateral. These principles can be distilled as follows:

4.1 Validation of the Floating Lien

The first principle is that a security interest remains valid despite the debtor’s broad liberty over the collateral. The law explicitly validates the idea that collateral can be part of the debtor’s ongoing business operations (often called a “floating lien” on inventory, receivables, or other circulating assets).

The debtor’s ability to sell inventory, use inventory to produce other goods, collect accounts receivable, or otherwise deal with the collateral in the ordinary course does not, by itself, void the creditor’s security interest in those assets or their proceeds.

This principle revolutionized secured lending by allowing businesses to use their assets normally while those assets secure a loan.

4.2 No Inherent Fraud from Debtor Control

UCC 9-205 establishes that giving the debtor control and use of collateral is not inherently a “fraudulent” arrangement vis-à-vis other creditors.

In legal terms, earlier doctrines outside the UCC sometimes treated such arrangements with suspicion (as if the debtor having unfettered control meant the lien was a sham to mislead others). Article 9 rejects that notion by statute.

The principle here is that as long as the security interest is properly created and perfected under the UCC, the mere fact that the debtor can use or even deplete the collateral does not make it a fraud on other creditors.

This legitimizes common arrangements where inventory is constantly sold and replaced or receivables are collected and new ones generated, under a continuous lien. It assures that creditors extending loans on such collateral do not lose their rights simply because the collateral is in motion.

4.3 Optional, Not Mandatory, Monitoring

Another key principle from UCC 9-205 is that the secured party is not legally required to monitor the collateral’s sale or demand the substitution of collateral in order to maintain the security interest.

The statute’s reference to the secured party not needing to require the debtor to account for proceeds or replace collateral means that the law does not impose those duties as conditions of validity.

This reflects the principle of freedom of contract and business judgment: lenders and borrowers can agree on whatever monitoring or accountings they see fit (and in practice, many lenders will have covenants about how proceeds are handled), but these are not statutory mandates.

The legal validity of the security interest doesn’t hinge on the creditor compelling the debtor to remit all the sales proceeds or continually add new inventory.

Thus, UCC 9-205 makes clear that any policing of collateral is a contractual matter, not a baseline legal requirement under Article 9. The secured party’s forbearance or lack of oversight will not itself be treated as a waiver of the security interest or evidence of invalidity.

4.4 Preservation of Formal Requirements

Finally, UCC 9-205 reinforces the principle that general flexibility has limits where the UCC’s formal requirements apply. By stating that requirements of possession are not relaxed, the provision reminds us that certain types of collateral or certain methods of perfection still demand adherence to formal steps.

For example, if the collateral is a negotiable instrument or money that by UCC rules must be in the secured party’s possession (or control, in the case of deposit accounts or letter-of-credit rights) to perfect the interest, then giving the debtor free rein in that context could indeed be problematic.

This principle ensures that UCC 9-205’s broad permission is not misread to override perfection rules: a creditor cannot rely on UCC 9-205 to claim a perfected security interest in a type of collateral that the debtor kept, when the law required the creditor to take possession for perfection.

In short, the general rule of validity amid debtor control holds true only if the security interest is properly perfected by appropriate means. The UCC balances flexibility with the necessity of proper notice or control measures where needed.

These legal principles established by UCC 9-205 collectively enable a secure yet flexible system. They confirm that a well-formed security interest will not be undermined by the debtor’s ordinary use of collateral, which is vital for the functioning of most businesses.

At the same time, they maintain the integrity of the secured transactions framework by insisting that fundamental perfection requirements are respected.

5. Conclusion

UCC Article 9-205 ensures that a security interest in personal property remains effective and enforceable even when the debtor retains the ability to use, sell, or otherwise deal with the collateral in an unrestricted manner.

By removing the cloud of invalidity or fraud from such arrangements, UCC 9-205 cements the legality of the “floating lien,” which is fundamental to financing arrangements for inventory, accounts receivable, and other circulating assets.

Within the larger framework of Article 9, this provision works alongside rules on attachment, after-acquired property, and proceeds to create a coherent system where lenders can confidently extend credit and debtors can continue business operations.

The key legal principles it establishes — validating debtor control over collateral, eliminating an obligation of the secured party to impose controls, and preserving necessary perfection requirements — all contribute to a balanced secured credit regime.