a—
Conditional Sales as Substance over Form

U.C.C. § 2-401(2) states, in effect, that even if a seller and buyer expressly agree that the passage of title in a good which is sold on credit is conditioned upon the buyer's payment in full of the purchase price, the U.C.C will treat the transaction as though title vested in the good to the buyer immediately. The seller will only have a purchase money security interest in the good, subject to the perfection and other requirements of Article 9. This can be read, at first blush, as not merely a rejection or disaggregation of "Title" analysis but an abrogation of freedom of contract. These impressions are inaccurate.

[230] U.C.C. § 2-105(2).

[231] This idea of property as legal relations with respect to an external object or res is also included in the requirements of Article 9 and the Bankruptcy Code that a security interest cannot attach until the debtor obtains "rights in the property." U.C.C. § 9-203(1)(c) and Bankruptcy Code § 547(e)(3). It is meaningless to speak of the property right known as a security interest without an object called collateral because the rights conveyed by the debtor to the secured party include precisely the rights to take possession (U.C.C. § 9-503), and realize value by either alienating (the basic remedy under Article 9 is to sell the collateral in a foreclosure sale, U.C.C. § § 9-504 and 505) or enjoying identifiable collateral. If the collateral consists of a right of payment, the secured party has the alternate remedy of collecting the payment rather than selling the collateral. U.C.C § 9-502. A secured party may also, under some circumstances, exercise the right of strict foreclosure under which it can become the "owner" of the collateral with full rights of possession, enjoyment, and alienation. U.C.C. § 9-505(2).

U.C.C. § 2-401(2) can only be understood in context. U.C.C. § 9-102(1)(a) provides that Article 9 applies "to any transaction (regardless of its form) which is intended to create a security interest in personal property or fixtures. . . ." U.C.C. § 2-401(2) is not, therefore, a rejection of property or freedom of contract per se but merely a restatement of the general U.C.C principle that substance should prevail over form.^[232] A selfserving statement as to the location of "Title" standing alone should not necessarily determine all property-related issues for all commercial-law purposes. This is a corollary to the proposition which I discussed in section II.B of this chapter that conveyances of property, which affect third-party rights, should be "objectively" recognizable and verifiable by third parties. Among themselves (i.e., contract), the two parties may characterize their relationship according to their private, subjective, idiosyncratic will. But if they wish to bind third parties (property), their actions must be public, objective, and recognized by the community. In other words, if possession (title) must be objectified and if exchange (conveyancing) is the process by which possession is altered, the contract of conveyance should also have a Community Objective aspect.

In contradistinction, common-law "Title" doctrine raised form over substance. The (subjective) declaration of the location of "Title" determined property issues despite, not because of, the allocation of the (objective) substantive rights constituting property. Llewellyn called such

[232] As emphasized by Arthur Corbin in an early defense of the then proposed Article 2, the article on sales does not even eschew the term "title." What it did do is avoid using it in the rigid and totemic fashion of the common law. Rather, it reflects a decision that since the word "title" is such a variable term—one that can create an illusion of certainty—the code drafter should use it

in a cheerful spirit, without fear and without reproach—without fear that others will give it any specific meaning that will cause misunderstanding, and without the reproaches that are sure to follow if he tries to require his readers to accept it with a specific and limited meaning.

Arthur L. Corbin, The Uniform Commercial Code—Sales, Should It Be Enacted? 59 Yale L.J. 821, 825 (1950). Consequently,

no attempt is made to define the term "title". . . . [T]he Code adopt[s] the "cheerful" alternative that is listed above; . . . [it] does not attempt a definition. . . . [The primary difference between Article 2 and the earlier Uniform Sales Act is that] the Code everywhere puts more emphasis upon the operative facts on which stated legal results depend and warns us that those legal results are not determined by such undefined concepts as "title" or "property in the goods." By such emphasis and warning, the attention of both merchant and lawyer are focussed on the vitally important factors and not on the undefined and inoperative concepts.

Id . at 826–27.

declarations of the form of "Title" over the substance of property "paper thunderings."^[233]

Formal declarations of "Title" become even more troublesome when one examines the substance of the typical mercantile transaction. During the sales process, "Title" (understood as the totality of all incidences of property) by definition cannot be definitively located because it is a moving target. It cannot, therefore, be fixed through the subjective intent of the contracting parties.^[234] This was precisely Llewellyn's criticism of the common law of conditional sales in which

the papers . . . make clear that it is not to be a sale, that "property" is not to pass. Something is to pass: The "buyer" is to get possession, and privileges of user, and come under a solid debt for the price; but "property" he is not to get.^[235]

In other words, in a so-called conditional sale the transferee has conditionally acquired significant elements of ownership—the right to immediate physical possession and use. Although the transferee in these transactions may not immediately have the third traditional right of alienation, it is anticipated that she will obtain this right as well upon the payment of the purchase price.^[236] Indeed, even when the further alienation of the entire property interest in the collateral by the buyer-debtor is wrongful under the terms of the contract, the debtor always has the power to convey her equity in the collateral.^[237]

The seller–secured party also has some property rights in the good. In section II.B of this chapter I discussed how a secured party has rights to repossess the good, and to alienate it in a foreclosure sale or to use it through collection or, less often, in strict foreclosure. Since buyer and seller can both be said to have some form of property rights in a conditionally

[233] Llewellyn, Across Sales on Horseback, supra note 202, at 733.

[234] "Now when the location of 'the property' in the wares thus gets far enough away from homely fact to need a lawyer to decide about it, but is supposed to be determined by the intentions of parties who are not lawyers, that is not so good." Id .

[235] Id . at 729. He makes a similar analysis of trust receipts and reservation of title.

[236] These transactions can, for all their surface strangeness, claim as of right to be included in the law of Sales, because if carried to intended completion and fruition they will result in passage from a seller to a buyer of all those rights and other Hohfeldian desirabilities we know together as "property in specific goods."

Id . at 730.

[237] U.C.C § 9-311. Moreover, in some cases she can even convey the secured party's interest in the collateral as well. For example, in some circumstances, a buyer of goods in the ordinary course takes free of the claims of security interests created by his seller. U.C.C. § 9-307(1).

sold good, we cannot say that either party owns the good free and clear—that is, full "Title." Nevertheless, in our legal system, when property rights are divided, we customarily say one party "owns" the property, subject to the rights of the other party. Consequently, we need to make a pragmatic decision as to which of the parties—the conditional seller or the buyer—will be called the "owner."

If property should be "objective," then all transactions structured in the same way should be given the same legal treatment. The drafters of the U.C.C. made a pragmatic decision that the division of the significant incidences of property in a conditional sale is substantially identical with the division in a hypothecation.^[238] We are accustomed to call the debtor's present rights in a hypothecation "ownership." These rights consist of the residual value in the collateral after payment of the secured transaction. As a buyer in a conditional sale similarly acquires the residual upon payment of the purchase price, it seems consistent also to call the conditional buyer the "owner."^[239]

In contradistinction, the common law allowed the private, subjective intent or opinion of the contracting parties to override the public, objective analysis of the transaction—that is, form governed over substance.

[238] In both a conditional sale and a hypothecation, the buyer-debtor's rights of possession and use, and her power of alienation, are immediately exercisable. The seller–secured party's rights are subject to a condition precedent—the buyer's default under the sales contract, or the debtor's default under the secured obligation.

[239] I am not arguing that there is any a priori reason why the debtor-buyer need be deemed the "owner." Actual decisions such as when property interests are deemed sufficiently objectively manifest as to be granted legal recognition, or how to allocate property interests, are matters of positive law, not jurisprudence, and can only be decided by practical reasoning rather than strict logic. I believe that in this specific case, the drafters of the U.C.C. made a pragmatic decision that although conditional sales and hypothecations are not identical, their objectively determinable allocation of certain important incidences of property are so similar that they should be given similar legal treatment.

I am also not arguing that property theory demands that at any one time there must be a party designated as the "owner" of the property. It is merely the historically contingent fact in our legal system that we do so. One could imagine alternate approaches when property interests in the same res are divided, as in the cases of hypothecations and conditional sales. For example, we could have developed something similar to the common-law estates. Under such an analysis, neither the debtor nor the secured party would be deemed to be the "owner" of the collateral in the sense of being the holder of the equivalent of fee simple absolute, but rather, they would have some limited interest or "estate" in the good. Actually, for some purposes we do so. We sometimes speak of the debtor owning the "equity" in collateral, to distinguish this from ownership free and clear. Similarly, even in states which have traditional mortgages rather than deeds of trust, consumers often colloquially speak of their mortgage bank as "owning" their houses. This reflects an intuitive understanding that a debtor's "ownership" of collateral subject to a security interest is not, substantively, equivalent to fee simple absolute.

This is inconsistent with the competing common-law doctrine of ostensible ownership—property interests which are not open and notorious are constructively fraudulent against creditors.^[240]

In other words, the concept of location of "Title" as a matter of subjective intent is inadequate in theory and practice to the lengthy processes of mercantile sales which require property to be determinable by objective evidence. Accordingly, Llewellyn described Article 2's treatment of title as follows:

[A]n objectively manifested act becomes the title-passing point without regard to the intention of the parties to pass or retain title. Such intention is controlling under present law.^[241]

This is why U.C.C. § 2-401 provides that the objective rules of Articles 2 and 9 apply despite subjective declarations of the location of "Title" to the contrary.^[242]

[240] Specifically, as Llewellyn noted, such common-law terminology as "trust receipt" and "reservation of title" merely "perfumed what might otherwise have smelt like 'secret lien' or that rat in Denmark: 'secret chattel mortgage on a stock in trade.'" Llewellyn, Across Sales on Horseback, supra note 202, at 730. Llewellyn had earlier raised a similar point in his casebook. Llewellyn, Sales, supra note 191, at 705. Elsewhere in this casebook, Llewellyn raised the question of form and substance in the opposite case where the form of the contract purports to transfer title to the buyer, but the substantive elements of property remain in the seller:

We turn now first of all to the more primitive situation where the dicker deals with existing goods, where the parties used language that looks like a present sale, and the question is: whether they have accomplished their apparent purpose. Here, as always, the first question is: Is this a present sale or a contract for sale. Only after that question is settled for the second of these alternatives, does the question arise: what obligation rests on S? And: what is the effect, under the contract, of S's acts of purported performance?

Id . at 574.

If the common-law "Title" analysis is inadequate in those cases where the parties actually subjectively allocate title in a conditional sales contract, it is absurd in those cases where the parties do not actually expressly contract as to the location of title. In this case the courts looked to other aspects of the contract to determine the parties' constructive intent. But this approach often resulted in different determinations of the parties' "intent" based on what questions were asked and which parts of the sales contract were examined.

And when . . . "the property" bounces around from party to party according to the issue, it begins to look as if "the property in the goods," as an issue-determiner, were in the mercantile cases a farmer far from the dell, and none too well adjusted to the new environment.

Llewellyn, Across Sales on Horseback, supra note 202, at 733.

[241] Llewellyn, Why a Commercial Code? supra note 198, at 787.

[242] An earlier version of Official Comment 1 to this section reflected the Llewellynesque reasoning even more clearly than the final version of the comment. It originally read:This article . . . deals with the issues between seller and buyer in terms of step-by-step performance or nonperformance under the contract for sale and not in terms of whether or not "title" to the goods has passed. Similarly the presence or absence of externally observable and determinable facts and not the location of "title," controls the rights of the seller's creditors and of good faith purchasers from either the buyer or the seller.

Quoted in Williston, supra note 190, at 568 (emphasis added).