Article Nine\u27s Treatment of Commingled Cash Proceeds in Non-Insolvency Cases

One of the most difficult questions arising under Article 9 of the Uniform Commercial Code is the extent to which a secured party\u27s interest in collateral continues to be enforceable against the proceeds generated upon disposition of that collateral. Much of the difficulty surrounding this issue springs from the fact that proceeds occupy a position at the nexus of two competing Code policies. On the one hand, Article 9 validates the floating lien and minimizes the extent to which a secured party must continue to police a transaction once his interest has been perfected. On the other hand, it is important for third parties to be able to ascertain the extent to which property in a debtor\u27s possession is subject to encumbrances. The problem becomes especially severe when the proceeds are cash proceeds that have become commingled with funds from other sources in the debtor\u27s general banking account. The Code addresses some of the problems associated with proceeds through a network of complex provisions, but many of the most important issues cannot be resolved by direct reference to statutory language. From these rules, it seems clear that the security interest does not continue in proceeds unless those proceeds remain identifiable, but nowhere does the Code define what is meant by the term identifiable. When cash proceeds become commingled with funds from other sources, an issue arises as to whether the commingling destroys identifiability. If it does, the security interest is no longer enforceable against the proceeds. Even without commingling, an argument can be made that depositing cash proceeds in a bank account prevents them from being recovered in specie, thereby rendering them unidentifiable. The question whether commingled cash proceeds remain identifiable may arise in a variety of contexts. In recent years, a series of cases has held that cash proceeds remain identifiable notwithstanding commingling in the debtor\u27s bank account. The courts in many of these cases have analogized the facts before them to situations in which constructive trusts have been imposed and have determined that the debtors should be regarded as trustees of funds which belong, in equity, to the secured parties. Once this basic analogy between security arrangements and constructive trusts has been established, the secured party is armed with tracing principles that allow him to determine, artificially, that portion of the deposit account that is allocable to proceeds. Under this approach, identifiable is construed as the equivalent of traceable. Ultimately, this article takes the position that the use of artificial tracing rules is not prohibited by the Code and that the recent cases reach a proper result notwithstanding the weaknesses of the constructive trust analogy. Since the UCC encourages secured parties to permit debtors to retain proceeds and use them in conducting their businesses pending default, it makes sense to give secured parties who make use of these liberal provisions some protection. Given the nature of the potential priority conflicts and the fact that third parties will rarely have relied on the funds in the account in making extensions of credit, the courts are justified in developing remedies to assist secured parties, although it should be recognized that the constructive trust is being employed as a fiction to permit use of these remedies. On the other hand, it can be argued that while the Code validates the floating lien it makes good sense to build in incentives for the secured party to engage in a modicum of policing. This article will suggest an approach to conflicts involving rights of set-off that will penalize the secured party for permitting commingling in situations where banks actually rely on funds in the account in deciding to extend credit without completely stripping him of his security interest in the proceeds. This article will approach the issues by examining the situations in which commingling is likely to occur, reviewing the right to trace proceeds under some of the pre-Code financing devices, and analyzing the use of the term identifiable in the context of Article 9. It will then examine the modem line of cases involving secured parties\u27 claims to commingled cash proceeds and will conclude by suggesting how some of the potential conflicts can be resolved in a manner that protects the interests of secured parties while remaining sufficiently flexible to grant priority to third parties in the relatively rare situations where the equities warrant such a result