Secured Transactions – Lesson 5

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In this video, 20.03 – Secured Transactions – Lesson 5, Roger Philipp, CPA, CGMA, begins with a vivid example of Sony knocking on his door demanding the return of his television that he had purchased at Costco. The absurdity of the situation illustrates why the secured transaction inventory rule exists.

The purpose of the inventory rule is to facilitate trade. This means that when you, as the buyer, purchase an asset that is held as inventory in the hands of the seller, you are released from any prior security interest in the asset. It does not matter if the asset is inventory, consumer goods or equipment in the hands of you as the buyer, as long as it is inventory in the hands of the seller.

The inventory rule does not release you from your security interest, but it does release you from all prior security interests. In other words, if you fail to pay a store for an asset you bought on credit, the store can still come back and demand the asset back. However, if the store fails to pay the wholesaler from whom it bought the asset on credit, the wholesaler cannot come to you and demand the asset back.

Roger also reviews the perfection of a security interest through a PMSI (Purchase Money Security Interest) and the 20-day rule for closing the third-party gap in PMSIs when the goods are consumer goods or the equipment is in the hands of the buyer.

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Preview the video transcript:

Let's talk about the inventory rule. The inventory rule is a special rule. And think about it like this: Let's say I go to the store and I buy a big screen TV. I love it and I'm excited to bring it home. And then I think, "You know what I need? I think I need a DVD, a DVR, and a Blu-ray. I don't even know what the heck is new and current. But I need one of those."

So I go to my favorite store, Costco. I walk in and I see this beautiful Sony Blu-ray, Schmoolie-ray, or whatever player. I bring it up to the front and I say, "Here's $200." Here you go, before I pay you, have you paid Sony, Mr. Costco? Because if not, I don't want to be sitting there with popcorn and friends and suddenly, "Hello?" Uh, yeah. Sony is at the door. Hmm, honey, did you invite Sony? No, "Hey, Sony, what's going on?" And they come in and say, "Hey, Costco never paid us. We're taking the Blu-ray player back."

What, how would I know? Well, you know what, to stimulate sales, to stimulate trade, they say, "You know what? When you buy the item and it's in the seller's hands as inventory, you get it without any prior interest. You don't get it without the interest that you create. But you get it without any prior interest, even if you are aware of it."

For example, let's say I come here and I remove my points. Let's say this is called the inventory rule, inventory rule. Here's the manufacturer, here's the wholesaler, here's the retailer of the goods. He sells them to another retailer. He sells them to a consumer, and he sells them to a company that uses them as equipment.

All right, here's the rule. The manufacturer sells it to the wholesaler. What does the wholesaler do? He files a financing statement. He completes his claims. Now, if the wholesaler goes bankrupt, he has the right to get the claims back. If the wholesaler sells it for cash, he has the right to seize the proceeds. He can take other assets, other inventory, etc.
But when the wholesaler sells it to that person, what was it when they bought it… It doesn't matter to them what it is. What was it in the hands of the seller? To them, it's inventory, to them, it's inventory, to them, it's inventory, to them, it's inventory, to them, it's consumer goods, to them, it's equipment.

All right, what does that mean for the seller? To them, it's inventory, you get it without any interest up front. If you create interest, you don't get it without interest. But if they buy it from that person, that person can't come to them and take it back, even if they haven't paid. They can take it back, but if I pay cash, I'm walking away. That's called the inventory rule.