10.4 Secured Transactions, Bankruptcy, and Priority

Why Priority Rules Matter

REG uses debtor-creditor facts because they fuse law, accounting, and risk. A CPA may encounter pledged inventory, assigned receivables, factoring, loan covenants, or going-concern bankruptcy disclosures. The 2026 REG blueprint includes debtor-creditor relationships, secured vs. unsecured creditors, perfection of security interests, and federal bankruptcy distribution. Analyze every fact pattern in five steps.

Article 9: Attachment First

A security interest under UCC Article 9 gives a creditor rights in collateral if the debtor defaults. The first question is always attachment — without it, the creditor has no enforceable interest even against the debtor. Attachment requires three elements:

1. Value is given by the secured party (e.g., the loan).
2. The debtor has rights in the collateral (owns it or has authority to encumber it).
3. The debtor authenticates a security agreement that reasonably describes the collateral — OR the secured party takes possession or control as a substitute.

Perfection and Priority

Perfection makes the interest effective against third parties. Methods:

• Filing a financing statement (UCC-1) — the default method for equipment, inventory, and accounts receivable. The filing names the debtor and indicates the collateral.
• Possession — used for instruments, money, negotiable documents (a pledge).
• Control — required for deposit accounts and investment property.
• Automatic perfection — a purchase-money security interest (PMSI) in consumer goods perfects the instant it attaches, with no filing.

Priority generally follows the first-to-file-or-perfect rule, and a perfected creditor beats an unperfected or unsecured creditor in the same collateral. Two exceptions dominate the exam:

• PMSI superpriority. A PMSI in equipment perfected within 20 days of the debtor receiving possession beats an earlier perfected interest. A PMSI in inventory needs perfection before the debtor receives the goods plus authenticated notice to prior inventory secured parties.
• Buyer in ordinary course (BIOC). A customer buying inventory in the ordinary course takes free of a security interest created by the seller, even if perfected — otherwise no one could safely shop at a financed store.

Default Remedies

After default, a secured party may repossess collateral without breach of the peace (no force, no entering a closed dwelling over objection) or use judicial process. Any disposition must be commercially reasonable with proper notice to the debtor. Sale proceeds are applied in order: (1) reasonable collection and disposition expenses, (2) the secured debt, (3) subordinate security interests, with any surplus returned to the debtor. If proceeds fall short, the debtor owes a deficiency unless a consumer-goods or other rule limits it.

The secured party may instead propose to retain the collateral in full or partial satisfaction (strict foreclosure), but not for most consumer goods where the debtor has paid 60% or more.

Bankruptcy Overlay

Filing a petition instantly creates two effects: the bankruptcy estate (broad debtor property interests) and the automatic stay (Sec. 362), which halts most collection, lawsuits, and repossessions. A secured creditor must obtain relief from the stay before enforcing against collateral. The trustee can use avoidance powers — most testably the preference rule: payments to an ordinary creditor within 90 days before filing (one year for insiders) on antecedent debt may be clawed back.

Distribution waterfall (Sec. 507). Value is paid in strict order:

Within priority unsecured claims, domestic support obligations rank highest, then administrative expenses, then a capped amount of recent employee wages, then certain taxes.

Chapter map. Chapter 7 liquidates non-exempt assets and discharges most remaining debts; Chapter 11 is reorganization, often with the debtor operating as debtor in possession; Chapter 13 is an individual wage-earner repayment plan over three to five years. Some debts are nondischargeable regardless of chapter: most taxes, student loans (absent undue hardship), domestic support, and debts from fraud or willful injury. Avoid memorizing inflation-indexed debt limits — focus on rights, ranking, the stay, avoidance powers, and dischargeability.

Worked example. Bank A perfected a security interest in a debtor's inventory in 2024. Supplier B has an unpaid 2026 invoice and no collateral. The debtor files Chapter 7. Bank A is paid first from the inventory it secured; Supplier B is a general unsecured creditor sharing whatever remains. Bankruptcy imposes the stay but does not erase Bank A's perfected secured status.

Exam Pattern

Separate state-law secured status from federal bankruptcy consequences. Ask in sequence: Did the interest attach? Was it perfected, and how? Does a PMSI or BIOC exception flip priority? Did bankruptcy impose a stay or trigger a preference or distribution shift?