UCC Article 9-207 Analysis and Commentary: Rights and Obligations of the Secured Creditor in Possession or Control
1. Introduction to UCC Article 9-207
UCC Article 9-207 of Article 9 details the obligations and rights of a secured party that has possession or control of collateral.
In such situations, the secured creditor/party must abide by certain duties to protect the debtor’s interest in the property, and it gains certain rights or privileges in handling that collateral.
This article analyses UCC 9-207’s obligations and rights and explains how this section interacts with other parts of Article 9.
2. Duty of Care – UCC 9-207(a)
Subsection (a) establishes the fundamental duty of reasonable care a secured party must fulfil when it has possession of collateral.
The secured party “shall use reasonable care in the custody and preservation of collateral in the secured party’s possession.” Practically, the secured party must take reasonable steps to protect and maintain the collateral’s value.
What constitutes reasonable care depends on the nature of the collateral. For example, if the collateral is machinery, the secured party should store and handle it in a way that prevents rust or damage; if the collateral is valuable documents or instruments, they should be kept secure from loss or deterioration (e.g. in a dry, locked location).
For certain kinds of collateral like chattel paper (a record evidencing a monetary obligation together with a security interest in or lease of goods) or an instrument (e.g. a promissory note), reasonable care explicitly includes taking necessary steps to preserve rights against prior parties, unless the debtor and secured party agree otherwise.
This means if a secured party holds a promissory note as collateral, part of its duty of care is to ensure that nothing is done to impair the note’s enforceability (such as preserving any indorsements or not letting relevant legal rights lapse).
Essentially, the secured party should not let the legal rights or value of the collateral be undermined through inaction or negligence.
This duty is fundamental and cannot be fully disclaimed by agreement (though the parties may agree on specific standards of care as long as they are reasonable).
The requirement reflects the debtor’s continuing ownership interest in the collateral: even though the secured party holds the property as security, the debtor should not suffer a needless loss of value due to the secured party’s neglect.
3. Rights and Duties of Secured Party in Possession – UCC 9-207(b)
Subsection (b) lists specific rights and duties that apply when the secured party has possession of the collateral (assuming the special exception in subsection (d) does not override them).
These provisions address the practical realities of one party holding another’s property as collateral:
3.1 Reimbursement for Expenses
The secured party may charge the debtor for reasonable expenses incurred in the custody, preservation, use, or operation of the collateral.
This includes costs like insurance premiums, taxes on the collateral, storage fees, and necessary maintenance or repairs. Such expenses become part of the secured debt, meaning the debtor ultimately pays for the preservation of their own collateral.
3.2 Risk of Loss on the Debtor
If a disaster or accident (fire, theft, etc.) destroys or damages the collateral without the secured party’s fault, the secured party is not responsible for the loss.
The debt is not reduced (except to the extent insurance covers the damage), so the debtor bears the loss. This outcome encourages debtors to insure their collateral and makes clear the secured party isn’t acting as an insurer.
3.3 Maintaining Identifiability of Collateral
The secured party must keep the collateral identifiable. The secured party should segregate or label the collateral so it can be recognised as the debtor’s property.
Fungible collateral (interchangeable items like grain or oil) is an exception – it may be commingled with other like goods, with the debtor’s security interest attaching to a proportionate share of the whole. Keeping collateral identifiable ensures the debtor’s property is tracked and can be accounted for.
3.4 Limited Right to Use or Operate Collateral
Generally, a secured party holding collateral has no right to use it, since it still belongs to the debtor. UCC 9-207(b)(4) provides a few narrow circumstances in which the secured party may use or operate the collateral:
- Preservation of Collateral: The secured party can use or run the collateral if doing so is necessary to preserve it or maintain its value. For instance, periodically starting an engine to keep it in working condition or feeding and caring for livestock would be allowed uses.
- Court Order: The secured party may use the collateral if authorised by a court. In rare situations a court might authorise the secured party to use collateral to preserve its value in an extraordinary way.
- Debtor’s Permission (Non-Consumer Goods): If the collateral is not consumer goods (i.e. it is used for business/commercial purposes), the debtor can agree to allow the secured party to use or operate the collateral. Any such agreement must be explicit, and even then it’s invalid for consumer goods. In other words, for personal-use items, even the debtor’s consent cannot give the secured party the right to use the collateral (beyond what’s necessary to preserve it or what a court orders). This protects consumers from a secured party taking advantage of their property for its own benefit.
Subsection (b) ensures that a secured party in possession of collateral acts fairly. The secured party can recover its costs and isn’t accountable for accidents beyond its control, but it must safeguard the property’s identity and generally refrain from using the collateral except as explicitly allowed (especially when it comes to consumer goods).
4. Handling Proceeds and Further Security Interests – UCC 9-207(c)
Subsection (c) addresses what happens if collateral in the secured party’s possession or control yields benefits or proceeds, and it addresses the secured party’s ability to use the collateral as part of another security transaction.
These rules apply when the secured party has either possession of the collateral or control of it (control being a concept used for certain collateral like deposit accounts, investment property, or electronic chattel paper):
4.1 Holding and Applying Proceeds
If the secured party receives proceeds from the collateral, how those proceeds must be handled depends on their form:
4.1.1 Non-Monetary Proceeds
The secured party may hold any non-cash proceeds as additional collateral. For example, if the collateral is stock and it splits or pays a stock dividend (issuing new shares), the secured party can hold those new shares as part of the collateral.
This rule is consistent with the general principle that a security interest extends to proceeds of collateral.
4.1.2 Money Proceeds
If the collateral generates money (cash proceeds) – such as interest payments, cash dividends, or rents from the collateral – the secured party has a duty to either apply that money to the outstanding debt or give it to the debtor.
The secured party should not keep cash proceeds for itself without crediting them against the obligation. This ensures the debtor benefits from any cash value coming from the collateral.
For instance, cash income produced by the collateral will reduce the debt or be returned, rather than being pocketed by the secured party.
4.1.3 Re-pledging the Collateral
UCC 9-207(c)(3) allows the secured party to create a security interest in the collateral – in other words, the secured party can re-pledge or re-hypothecate the debtor’s collateral as collateral for the secured party’s own obligations to another creditor.
For example, a bank that holds a borrower’s securities as collateral for a loan might pledge those securities to a third party to secure a loan of its own.
The law permits this to facilitate the free flow of credit using collateral, but the debtor still retains the right to recover the collateral by paying off the debt; any third-party creditor holding the re-pledged collateral takes it subject to the debtor’s interest and the original security interest.
Thus, the secured party gains flexibility to use pledged assets in further transactions, yet the debtor’s ultimate right to the collateral is preserved.
5. Exception for Buyers of Receivables and Consignors – UCC 9-207(d)
Subsection (d) provides an exception to the above rules for certain transactions where the secured party isn’t a typical lender holding the debtor’s collateral, but instead is a party like a buyer of receivables or a consignor of goods.
Specifically, if the secured party is a buyer of accounts, chattel paper, payment intangibles, or promissory notes, or a consignor (the owner of goods delivered to a consignee for sale), then the usual rules adjust: subsections (b) and (c) do not apply to such a secured party.
The duty of care under subsection (a) applies only if the parties’ agreement provides for recourse against the debtor (meaning the buyer/consignee can turn back to the debtor if the receivable isn’t paid or the goods aren’t sold).
In a no-recourse outright sale, the buyer essentially owns the assets and owes no duty of care to the seller. Likewise, a consignee of goods primarily owes duties to the consignor as defined by their consignment agreement, not the general rules of UCC 9-207(b) and (c).
This exception recognises that these situations are different from a standard secured-loan scenario. A factor who buys accounts or a bank that purchases a note will handle those assets for its own benefit, and a consignee in possession of consigned inventory manages that inventory under the consignment deal.
It would not make sense to impose the standard obligations of 9-207 (like keeping collateral separate or not using it) on someone who, for all practical purposes, owns the collateral or is dealing with it under a special arrangement.
Thus, UCC 9-207(d) carves out these cases so that the general rights and duties of UCC 9-207 give way to the specific nature of the transaction.
6. UCC Article 9-207’s Interaction with Other Article 9 Provisions
UCC Article 9-207 works in concert with other provisions in Article 9. Key interactions include:
6.1 When Collateral is Held (Perfection and Post-Default)
Whenever a secured party holds collateral – whether to perfect its interest or after default – it must comply with UCC 9-207.
For example, if a secured party perfects by possession or control (see UCC 9-313, UCC 9-104) or repossesses collateral upon default (UCC 9-609), the duties of care and proper handling under 9-207 still apply until the collateral is returned to the debtor or disposed of.
A debtor’s default does not wipe out these obligations; the secured party remains responsible for safeguarding the collateral and dealing with it appropriately as long as it holds the collateral.
6.2 Non-Waivable Rules (UCC 9-602)
Article 9 contains certain debtor protections that cannot be waived. Notably, UCC 9-602 prohibits a debtor from waiving the limitation in UCC 9-207(b)(4)(C) that forbids a secured party’s use of consumer goods collateral.
No matter what a security agreement might say, a secured party in possession of the debtor’s personal-use property cannot use or operate that property except as UCC 9-207 allows (for preservation or with a court order).
This rule reflects a strong policy to protect consumer debtors. In general, while many of 9-207’s rules can be tailored by agreement in a business context, the debtor’s basic right to have their collateral (especially consumer goods) not be used by the secured party is inviolate.
6.3 Additional Duties upon Termination (UCC Article 9-208)
UCC 9-208 complements UCC 9-207 by requiring a secured party to promptly relinquish control of collateral (for example, by releasing a controlled deposit account or investment property) once the secured debt is paid off.
This ensures the secured party’s hold on the collateral ends when the secured transaction concludes. In effect, UCC 9-207 governs the secured party’s behaviour while the transaction is ongoing, and UCC Article 9-208 kicks in at the end to make sure any control or possession is properly released back to the debtor.
Conclusion
UCC Article 9-207 delineates clear responsibilities and rights for secured parties that take possession or control of a debtor’s collateral.
It protects the debtor’s interest by requiring the secured party to use reasonable care, keep the collateral identifiable, and properly apply or remit any proceeds.
At the same time, it gives the secured party practical rights such as reimbursement of expenses and, in commercial cases, the ability to use or even re-pledge the collateral under certain conditions.
Through its interaction with related sections (like the non-waiver provisions and the post-default and termination rules), UCC 9-207 maintains a balance between debtor protection and the secured party’s legitimate interests across the life of a secured transaction.
