Carol made a promissory note in the amount of $25,000 in favor of Barb on January 1 to be due in nine months. In exchange for a loan for her business, Barb granted Bank a security interest in this note on February 1 of the same year. Bank’s security interest in the note attached against Barb. Bank promptly filed a financing statement to perfect its interest in the note and did not take possession of the note.

On February 15 of the same year, Barb negotiated the note to Jim for $23,500, and Barb then spent this money on her business. Jim had no reason to know or suspect that Barb had granted a security interest in the note to the Bank and took the instrument in good faith and without notice of any defenses to payment on the instrument or other claims of ownership. If Barb defaults on her loan and does not pay Bank, which party is entitled to the $25,000 note and why?

Question

Carol made a promissory note in the amount of $25,000 in favor of Barb on January 1 to be due in nine months. In exchange for a loan for her business, Barb granted Bank a security interest in this note on February 1 of the same year. Bank’s security interest in the note attached against Barb. Bank promptly filed a financing statement to perfect its interest in the note and did not take possession of the note.

On February 15 of the same year, Barb negotiated the note to Jim for $23,500, and Barb then spent this money on her business. Jim had no reason to know or suspect that Barb had granted a security interest in the note to the Bank and took the instrument in good faith and without notice of any defenses to payment on the instrument or other claims of ownership. If Barb defaults on her loan and does not pay Bank, which party is entitled to the $25,000 note and why?

BlackTom AI · Accepted Answer

Revisiting the scenario, we’re looking at competing claims to the promissory note after Barb negotiates it to Jim.
Option 1: 'Jim is entitled to the note because Jim is a holder in due course who bought the note in good faith and paid value for it.' Although Jim can be a holder in due course, his rights are not unlimited when a secured party has a perfected security interest in the instrument itself. The Bank’s perfected security interest attaches to the note, and because Jim acquired the note from Barb after the security interest was created and perfected, Jim takes subject to that interest. In other words, Jim’s HDC status does not automatically defeat Bank’s security interest in the same instrument. Thus this option overstates Jim’s protection and is not correct in this context.
Option 2: 'Bank is entitled to the note because Bank filed a financing statement to perfect its interest in the note.' This line of reasoning aligns with secured transactions principles. Bank attached to Barb’s note when the security agreement was created (Barb granted a security interest on Feb 1), and it perfected that interest by filing a financing statement. Perfection by filing gives Bank priority against later creditors or transferees who are not holders in due course who took free of that security interest. Although Jim acquired the instrument, the Bank’s perfected security interest remains against the instrument itself, so the Bank has a superior claim to the note over Barb’s subsequent transferee. Hence this option is consistent with priority rules for secured interests in instruments and is correct.
Option 3: 'Jim is entitled to the note because Jim is a creditor.' Being a creditor does not automatically override a perfected security interest in the instrument. The status of creditor does not confer priority over a properly perfected security interest in a negotiable instrument. This makes the statement incorrect because it ignores the security interest’s priority.
Option 4: 'Bank is entitled to the note because it took a security interest in the note and is temporarily perfected for 20 days.' The notion of a 20-day temporary perfection window does not apply here to the Bank’s secured interest in the note. The Bank perfected its interest by filing from the outset, and there is no indication of a temporary perfection regime that would override or delay the superior rights conferred by proper perfection. Therefore this option is inaccurate.

ACCT:4300:0001 Fall25 Examination #2 - Accounting Ethics and Law- Requires Respondus LockDown Browser

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