ACC 543 Week 4 Negotiable Instruments and Secured Transactions Example

A Tractor Sold on a Note, a Bank's Floor-Plan Lien and a Repossession: Negotiable Instruments and Article 9 Security Interests at a Composite Farm Equipment Dealer

[Student Name]

University of Phoenix

ACC/543: Managerial Accounting & Legal Aspects of Business

Week 4 Assignment

[Instructor Name]

[Date]

The dealer, its lender, its customers and all figures are composites written for a model paper; the law is stated generally from the sources listed and varies in detail by state.

A composite dealer sells tractors, combines, balers and parts to farms in three counties. Many customers buy on credit, signing promissory notes secured by the equipment. The dealer sells some of those notes to a manufacturer-affiliated finance company to raise cash, and it finances its own inventory of new equipment through a bank floor-plan line. This year a grain farmer defaulted on a note for a combine. Every sale on credit creates a legal document whose wording decides who can collect, against whom and in what order, and the accountant's numbers depend on those answers. This paper applies the governing rules, which are stated generally and vary somewhat by state.

Is the Customer's Note Negotiable?

A farmer bought a tractor for $185,000, paying $35,000 down and signing a note promising to pay "to the order of" the dealer $150,000 plus 7.5% interest in 48 monthly installments. To be negotiable, an instrument must be an unconditional promise or order to pay a fixed amount of money, payable to bearer or to order, on demand or at a definite time, with no other undertaking (American Law Institute & Uniform Law Commission, 2022). The note meets each requirement: the promise is unconditional, the principal is fixed and interest is stated, it is payable to order and the installment dates are definite. A clause granting a security interest in the tractor does not destroy negotiability, since the code allows such provisions.

Selling the Note and Holder in Due Course

The dealer indorsed the note and sold it to the finance company for $146,000. A holder in due course takes an instrument for value, in good faith and without notice that it is overdue, dishonored or subject to a defense. The finance company paid value, dealt in good faith and had no notice of any problem, so it is a holder in due course.

The significance appears if the farmer later claims the tractor's transmission was defective. Breach of warranty is a personal defense, which a holder in due course takes free of; the farmer would have to pay the finance company and pursue the dealer for the warranty claim. A real defense, such as forgery of the farmer's signature, would survive. In consumer credit sales, a federal rule requires notes to preserve buyers' claims and defenses against later holders (16 C.F.R. § 433.2), but a tractor bought for a farming business is not a consumer purchase, so that rule does not apply here (Cheeseman, 2019).

The Accounting Effect of Selling Notes

The dealer sold the note with recourse: if the farmer defaults, the dealer must buy it back. For accounting, the dealer must decide whether the transfer is a sale or a secured borrowing, and a recourse obligation is recognized as a liability. The legal terms of the indorsement and purchase agreement therefore determine what appears on the dealer's balance sheet.

The Bank's Floor-Plan Security Interest

The dealer's bank lends against new equipment in inventory and takes a security interest in it. A security interest attaches when value is given, the debtor has rights in the collateral and the debtor has authenticated a security agreement describing the collateral. The bank advanced funds, the dealer owns the inventory and the security agreement covers all present and after-acquired inventory, so the interest attached. The bank perfected it by filing a financing statement with the secretary of state in the dealer's state of organization, which gives notice to other creditors.

Why Customers Take Free of the Bank's Lien

When the farmer bought the tractor, it was covered by the bank's floor-plan lien. A buyer in the ordinary course of business takes free of a security interest created by the seller, even if perfected and even if the buyer knows of it. The farmer bought in good faith from a dealer who sells such goods, so the farmer's tractor is free of the bank's lien. The bank's protection is its agreement requiring the dealer to repay the advance on each unit when it is sold, which the bank monitors through monthly inventory audits.

The Dealer's Own Security Interest and Priority

The dealer took a security interest in the tractor to secure the farmer's note. Because the security interest secures the purchase price of the collateral, it is a purchase-money security interest. The farmer's bank had an earlier-filed security interest in all of the farmer's equipment, including after-acquired equipment. Ordinarily, the first to file or perfect has priority. But a purchase-money security interest in equipment has priority over a conflicting security interest in the same collateral if it is perfected when the debtor receives the collateral or within 20 days afterward. The dealer filed within a week, so its interest in the tractor has priority over the farmer's bank.

Default and Repossession

A different customer, a grain farmer, stopped paying on a combine note after a poor harvest, owing $212,000. After default, a secured party may take possession of the collateral without judicial process if it can do so without a breach of the peace. The dealer's recovery agent retrieved the combine from an open field with no confrontation. The dealer must then dispose of it in a commercially reasonable manner, with notice to the debtor and any secondary obligors. It sold the combine at a regional equipment auction for $168,000, less $9,000 of transport and auction costs. The $53,000 deficiency remains owed by the farmer, and the dealer recorded an allowance for the portion it expects not to collect.

Checks and the Dealer's Cash

Negotiable instruments also include the checks customers use for down payments and parts. When a check for $12,400 from a parts customer was returned for insufficient funds, the dealer, as payee and holder, could pursue the drawer on the instrument and, under many state laws, recover statutory damages and costs after a written demand. The dealer now requires certified funds or electronic payment for down payments on equipment, because it releases the equipment when paid and cannot easily recover it if a check later bounces.

Why Secured Credit Exists

Mann (1997) studied lending practices and argued that security interests lower lenders' monitoring costs and limit borrowers' ability to take on further debt, which explains why secured lending dominates for small businesses and farms. The dealer's business model depends on that logic: secured notes make credit sales feasible, and the bank's floor-plan lien makes inventory financing possible.

Conclusion

The farmer's note is negotiable, and the finance company that bought it is a holder in due course, free of warranty defenses in this commercial sale. The bank's floor-plan lien attached and was perfected, but customers buying in the ordinary course take free of it. The dealer's purchase-money security interest has priority because it was filed within 20 days. On default, self-help repossession without breach of the peace and a commercially reasonable sale left a deficiency the dealer must estimate. Each legal outcome shaped an accounting number.

References

American Law Institute & Uniform Law Commission. (2022). Uniform commercial code: Official text and comments.

16 C.F.R. § 433.2 (2024).

Cheeseman, H. R. (2019). Business law: Legal environment, online commerce, business ethics, and international issues (10th ed.). Pearson.

Mann, R. J. (1997). Explaining the pattern of secured credit. Harvard Law Review, 110(3), 625-683. https://doi.org/10.2307/1342242