Commercial Finance (CF) is an established bank that lends funds to small and medium-sized businesses. CF typically lends between $250,000 and $2.5 million to retail sales establishments. In consideration for the lending of money, CF requires its borrowers to sign and execute promissory notes (installment notes evidencing the loan agreement and its terms) and security agreements to secure the obligations of its borrowers. In the security agreements, borrowers will typically pledge inventory, equipment, and accounts payable as collateral for the loans.

Last summer CF lent $800,000 to a small but growing retail florist business named Rosey's Garden (RG). RG intended to apply the loan proceeds to expand its growing operations by doubling the size of its greenhouse capacity and by purchasing new capital equipment such as sprinkler systems and heavy equipment. RG signed a promissory note obligating itself to pay back principal and interest over five years, and a security agreement pledging all its equipment, accounts payable, and inventory as collateral securing the loan. Because this was the first time that RG had borrowed to support its business operations, there were no other promissory notes or security agreements impairing RG's property at the time of the loan from CF.

Unfortunately for CF, its finance department forgot to file its security agreement at the Secretary of State's office, and therefore its security agreement was never perfected (although it did attach). Also, unbeknownst to CF, RG took out a second loan with another financier (the second creditor) six months after the CF loan, and that lender immediately perfected its security agreement by filing same with the Secretary of State. The latter security agreement claimed the same collateral as CF's security agreement.

Questions Posed:

1. Suppose that RG defaults on both its loans. Please discuss which lender will have priority over RG's equipment, accounts payable, and inventory when it comes time to repossess and sell the collateral?
2. Suppose that RG files for Chapter 11 bankruptcy protection and the automatic stay. In response, CF filed a lawsuit for breach of the promissory note in which it demanded immediate re-payment in full or foreclosure on the collateral under the security agreement. Will CF succeed in prosecuting its lawsuit? Defend your answer by describing the likely outcome of the lawsuit.
3. Briefly describe how each creditor (lender) will be classified in the "reorganization plan" as either a secured or non-secured creditor and discuss which creditor you suspect will be in a superior position for securing the repayment, partial or in full, of the debt in bankruptcy?