"A judge who finds himself face to face with a circular priority system typically reacts in the manner of a bull who has been goaded by the picadors: he paws the ground and roars with rage. The spectator can only sympathize with judge and bull." G. Gilmore, Security Interests in Personal Property, Chapter 39, sec. 39.1.

The following material describes some additional examples of circular priorities that could arise under the revised Article 9 along with a collection of "solutions" that have received judicial acceptance or that have been proposed by secondary authorities. The problem of circular priorities can arise in many contexts: (1) Real Property mortgage financing, (2) Bankruptcy/State Law interrelation, (3) Personal Property financing, (4) State law judgment liens and executions, (5) State or Federal Tax Liens vs. other types of state or federal claims. In all of these contexts, the problem is the same: A has priority over B who has priority over C who has priority over A. Thus:

1. A Circular Priority in the Context of Farm Financing.

2. A Circular Priority in the Context of Deposit Accounts.

3. A Collection of Proposed Solutions for Circular Priorities.

4. Additional Reading on Circular Priorities.

[A]ssume Community Bank has a security interest in Farmer's crops which are farm products and the crop input supplier has an agricultural lien in the crops. Farmer harvests and sells the crops to [an] elevator. If the elevator were a buyer in the ordinary course under the Food Security Act, priority in the farm products as against the security interest would be governed by that Act and would depend upon compliance with the applicable notice procedure set forth in that Act. The Food Security Act may not govern the contest between the agricultural lien claimant and the elevator because the Act has been interpreted to apply to priority of buyers as against consensual liens, not nonconsensual liens. If the buyer's priority as against an agricultural lien is not governed under the Food Security Act, then Revised Article 9's rule applies and requires the buyer to take delivery of the goods and give value prior to perfection of the agricultural lien in order to have priority over the agricultural lien. Assume that Community Bank and the agricultural lien claimant perfected prior to the elevator giving value and receiving delivery of the harvested crops. The buyer elevator is a buyer in the ordinary course under the Food Security Act and Community Bank, while perfected under Article 9, has not complied with the notice requirements of the Food Security Act which are different than Article 9 perfection. In addition, Community Bank has filed prior to the agricultural lien filing so under the first-to-file-or-perfect rule, Community Bank's interest in the crops has priority over the agricultural lien. A circular priority has been created. The elevator takes free of Bank's security interest but does not take free of the agricultural lien, and Bank's security interest has priority over the agricultural lien. If, on the other hand, Bank has complied with the Food Security Act notice as well as perfected under Revised Article 9, buyer would take the crops subject to the Bank's security interest, and under Revised Article 9, the buyer would also take the crops subject to the agricultural lien. [Footnotes have been omitted. ]

F. Possible Circular Priority Issues. Circular priority is a favorite of law professors. Up to now, it has been mostly a theoretical problem. By introducing nontemporal priority for perfection of deposit accounts, however, I think Revised Article 9 potentially creates the potential for havoc in many bankruptcies. I base my fears on the following hypothetical. Debtor, D, has a secured line of credit with asset-based lender, A. A has a properly perfected, and unavoidable in bankruptcy, security interest in D's inventory and all proceeds thereof. In addition, it is oversecured. D also has an account with Bank B, and B has a clause in its standard form deposit agreement granting B a security interest in the deposit account to secure all obligations running from D to B. Further assume that D owes B money and that the obligation exceeds the amount in the deposit account; that is, B is an undersecured creditor. Finally, assume that A and B have entered into an agreement pursuant to which B agrees to subordinate its security interest in the account to A's interest. Now assume that D sells inventory and deposits the proceeds in the account at B and such amount is traceable under local law. Immediately after the funds clear, D files for bankruptcy. As against the trustee, A's interest in the proceeds is perfected as identifiable proceeds of the sale of the inventory. As against B, however, A loses, since B has control of the account. But since B was undersecured, the transfer of the funds to B is preferential. It can thus be set aside by the estate representative, either the debtor's trustee in bankruptcy or the debtor in possession. After avoidance, the trustee steps into B's position. Section 551 states that "[a]ny transfer avoided . . . is preserved for the benefit of the estate." With the benefit of this statute, the trustee will take over B's position, and thus have priority over A with respect to the proceeds. The end result is the effective avoidance of A's interest in all proceeds on deposit at Bank B (even though outside of bankruptcy such proceeds were protected against lien creditors), simply because another creditor, Bank B, happened to be undersecured at the time of the filing.[Footnotes have been omitted. ]

For some years I have collected judicial or legislative solutions that have been advanced for "breaking the circle" in circular priority situations. The following article is a summation of my collection to date. I present it here, not in the belief that this is a pervasive problem of law practice or expenditure of judicial resources, but simply because I thought it might be helpful to provide others with a convenient resource to which they might turn if they happen upon a circular priority problem. None of the solutions is offered as "the answer." All of them have some merit and the choice is likely to depend on the position of the client of the moment.

In the possible solutions that follow, assume that A's claim is for $9000, B's claim is for $6000, C's claim is for $3000; and the fund available for distribution is $11,000. None of the solutions commands general acceptance and, occasionally, even within a single jurisdiction, different solutions will be used at different times. The solutions are roughly arranged in the order of complexity.

1. Pennsylvania rule. [1] Pay A first, then B, then C. Theory: A is prior to B who is prior to C.

Result: A -- 9; B -- 2; C -- 0

2. New Jersey rule. [2] Pay B first, then C, then A. Theory: Postpone A because A is the party responsible for the circuity by not filing promptly or at all. Between B and C, B is prior.

Result: B -- 6; C -- 3; A -- 2

3. New York and Texas rule. [3] Segregate A's claim from the fund. From A's claim, Pay C. Residue of A's claim goes to A. Apply the residue of the fund first to B, then to C and then to A. Theory: The effect of C's priority is to put C in A's shoes as to B. Operation: A's 9 less C's 3 leaves A 6. Nine already gone so B gets two.

Result: C -- 3; A -- 6; B -- 2

4. Maryland rule. [4] Segregate from the fund B's claim. Pay that first to A, remainder to B. Apply residue of fund first to C, then to A, then to B. Theory: C should be kept in C's original position, but between A and B, A will be paid first. Operation: B's 6 less A's 9 leaves A with 6 and B with 0. Balance of fund is 5. This goes 3 to C and 2 to A.

Result: A -- 6 + 2; B -- 0; C -- 3

5. Iowa Rule. [5] Segregate C's claim. Out of it carve B's claim and pay B, give the remainder of C's claim to C. Give the residue of the fund to A. Theory: Start with C because C is prior to original lien. Out of C's share it is fair that B be paid first because B is prior to C. By giving C the residue of C's claim after paying B, the net priority of B over A is retained. A is then entitled to the residue because A is prior to B. Query? What happens if the above steps do not exhaust the fund (i.e., if fund were $13,000 instead of $11,000)? Operation: C's 3 less B's 6 leaves C with 0 and B with 3. Balance of fund (11-3) goes to A.

Result: B -- 3; C -- 0; A -- 8

Just Expectations Rule

6. Day v. Munson variation. [6] Segregate A's claim and pay balance of fund to B. Restore A's claim to fund. Segregate B's claim and pay balance of fund to C. Then pay residue to A, then B, then C. Theory: Try to give each party his or her reasonable expectations, while at same time postponing A's payment until last because A is partly responsible for the circuity because A did not file or record A's interest.

Operation: A's 9 subtracted from 11 leaves 2; pay B 2. B's 6 subtracted from 11 leaves 5; pay C his whole 3; Residue (11 - 5) to A -- 6.

Result: B -- 2; C -- 3; A -- 6

7. Dixon variation (dissent in Hoag v. Sayre). [7] Segregate B's claim and pay C. Segregate A's claim and pay B. Residue to A then B then C. Theory: same as above.

Operation: B's 6 from 11 leaves 5; Pay C the whole 3 due C; A's 9 from 11 leaves 2; Pay B 2; Residue (11 - 5) 6 to A.

Result: C -- 3; B -- 2; A -- 6

8. Kocurek variation. [8] Segregate B's claim and pay balance to C. Subtract amount paid C from A's claim and pay A the difference. Residue then to B, then to A. Theory: same as above.

Operation: B's 6 from 11 leaves 5; Pay C the whole 3 due C; Subtract 3 paid C from A's 9; Pay A 6; Pay B remainder 11 - 9 = 2

Result: C -- 3; A -- 6; B -- 2

[Note: variations 6, 7 & 8 all reach same result, but it is suggested that the Kocourek method is the easiest formula to apply.]

9. Benson Rule. [9] (a) Treat each party as a junior lienholder and pay to each the amount of his claim as a junior lienholder. (b) If the fund is so small that no one has any junior lienholder claim simply divide it equally as a windfall. (c) If the fund is in excess of the junior lienholder claims, divide the excess equally as windfall. (d) If the fund is not large enough to pay all the junior lienholder claims, calculate the largest lesser amount the fund could have been without being exceed by the junior lienholder claims and distribute that amount as if it were the whole fund. Distribute the remainder equally among those not satisfied in the first operation. Theory: Each party is a junior lienholder so division of the fund should be made on the basis of their net claims after the interests prior to theirs has been set aside.

Operation: A's junior lienholder claim 11 - 3 = 8; B's junior lienholder claim 11 - 9 = 2; C-s junior lienholder claim 11 - 6 = 3 (Obviously, 11 - 6 is 5, but C's total claim is only 3). Fund of 11 is not sufficient to satisfy junior lienholder claims so alternative (3) is applicable. What is the amount at which the junior lienholder claims would have been capable of satisfaction? If fund had been 9 instead of 11, junior lienholder claims would have been 9 also. Fund of 9: A's junior lienholder claim 9 - 3 = 6; B's junior lienholder claim 9 - 9 = 0; C's junior lienholder claim 9 - 6 = 3

Therefore fund of 9 is distributed: A -- 6; B -- 0; C -- 3

Remaining 2 (actual fund of 11 minus 9 distributed above) is divided equally to A and B.

Result: A -- 6 + 1; B -- 0 + 1; C -- 3

10. Columbia L. Rev. Theory. [10] Ascertain what the junior lienholder's claims would be if the fund were of such size that the sum of the junior lienholders' claims were equal to what the fund is in fact. Pay these amounts to the respective claimants. Theory: Settle the whole matter on the basis of the relationship to the junior lienholder claims.

Operation: A's junior lienholder claim is 8 (11 - 3); B's junior lienholder claim is 2 (11 - 9); C's junior lienholder claim is 3 (11 - 6)

Fund is 11: Junior lienholder claims are 8 + 2 + 3 = 13

If fund were 10, junior lienholder claims would be 7 (10 - 3); 1 (10 - 9); 3 (10 - 6) = 11

Result: A -- 7; B -- 1; C -- 3

11. Bankruptcy Act of 1898 Theory. [11] [A = Secured Party ($9000); B = Administrative and Wage Claims ($6000); C = Tax Lien ($3000)]. Set aside the amount of the tax lien from the fund and from this amount pay administrative expenses first and wage claims next (per sec. 64(1) & (2)). Remainder, if any, to tax lien claimant. Balance of proceeds to holder of security interest.

Result: B -- 3; A -- 8; C -- 0

12. Bankruptcy Code Theory. [12] If the trustee already is the position of one of the creditors in the circle and is also able to defeat one of the other creditors, the trustee is entitled to preserve the defeated lien for the benefit of the estate.

Result: Trustee occupies two of the three positions on the circle, thereby breaking the circular priority.