SECURITY FOR CREDIT TRANSACTIONS
BAILMENTS AS SECURITY
Sec. 1 . Introduction. Today, much of the business of the world
is done on credit. It is natural that the person extending credit
should take some means to protect himself against credit losses,
particularly where the debtor is in a position to offer protection.
Quite often the security accorded the creditor consists of a lien
on property usually in the nature of a pledge or mortgage. A
pledge merely forms one of several bailments which may be used to
protect the person extending credit. Consignments, common-law
liens, and trust receipts are all forms of the bailment relationship,
and will, along with pledges, be treated in this chapter.
Sec. 2. Consignments. A consignment consists of a shipment
of goods by the owner, called the consignor, to an agent, called the
consignee, for the purpose of having them sold by the agent. A
manufacturer who considers a retailer a poor financial risk often
ships goods on consignment. In such a case the consignee, in dis-
posing of the goods, acts as an agent of the consignor and receives
a certain commission for his services. He holds, in trust for the
consignor, all funds received from the sale of the goods. If goods
are sold on credit, the consignor assumes the risk of collection, un-
less the consignee by agreement has guaranteed the collection of all
accounts. The consignee has implied authority to sell on credit un-
less there is a clear custom to the contrary or unless the contract
forbids it. Should he be careless in the selection of credit risks, he
would, according to the rules of agency, be liable for any resulting
All consignments are bailments. The consignor retains title, and
possession will ultimately revert to him, unless he, acting through
his agent, transfers title and possession to some third party. Thus
the ordinary rules of bailment govern the relationship. The risk
of loss, assuming the consignee exercises reasonable care, rests upon
the consignor unless the agreement between the parties imposes
upon the consignee the duty of carrying adequate insurance. The
consignor must pay the taxes on the goods, and his creditors alone
can levy on them, the creditors of the consignee having no interest
therein. 1 In this connection, attention should be called to the fact
that the consignee is entitled to assert a lien against goods in his
* Harris v. Coe et al., 1898, 71 Conn. 157, 41 Atl. 562; p. 759.
344 SECURITY FOR CREDIT TRANSACTIONS
possession for any amount owed to him by the consignor under the
consignment contract. Thus, the consignee might maintain a lien
for advances to the consignor, for freight or for insurance, where
these items have been paid for the benefit of the consignor. The
claims of the consignor's creditors in the consigned goods are sub-
ject to the contract rights of the consignee. Such liens as existed
for freight, insurance, and advances are superior to the claims of
judgment creditors of the consignor.
It is often quite difficult to distinguish between a consignment
and some form of sale. However, whenever the contract is so
worded as to make it possible for the consignor to call upon the
consignee for payment for the unsold goods, the transaction par-
takes of the nature of a sale and is no longer a consignment. In a
consignment, the consignee rests under a duty to account only for
the goods which have been sold. The consignor then repossesses
those goods which are unsold at the termination of the relationship.
It is also customary for the consignor to establish the retail price
of the goods to be sold, although this conduct is not necessarily an
incident of the relationship.
Sec. 3. Artisan's lien. From a very early date the common law
permitted one who expended labor or material upon the property
of another to retain possession of such property as security for his
compensation. This right was a personal one and, therefore, not
assignable. Furthermore, it did not arise where the bailor had con-
tracted for a period of credit. The lien arose only in case the bailee
was entitled to his compensation upon completion of the task as-
The common-law lien also existed in favor of public warehouse-
men and common carriers. 2 Since the law required them to supply
storage or carriage upon request, they were protected by a lien on
the goods entrusted to their care. By statute, this lien has been ex-
tended in many states to include all cases of storage.
It should be noted that the licnholder has no right to charge stor-
age for property in his possession, if he is retaining it merely for
the purpose of maintaining his lien. Thus, if the owner is willing
to take possession of his goods, although he is unable to pay the
charges against them, the right to charge storage ceases. Neither
does the lienholder have the right to use goods which he is retaining
as security for an indebtedness.
The artisan's lien is inferior to a prior lien of record or a condi-
tional vendor's claim but is superior to a later lien. The owner of
mortgaged property, who takes it to an artisan for repairs, creates a
3 Lewis v. Gray, 1912, 109 Me. 128, 83 Ail. 1; p. 760.
BAILMENTS AS SECURITY 345
lien thereon which is inferior to the equity of the mortgagee, since
the latter's claim arose first in point of time.
Sec. 4. Possession, The artisan's lien has been somewhat
modified by statute in the various states. Under the early law,
continued possession of the property was required. A surrender of
possession had the effect of canceling the lien, and a later return of
the property would not cause the lien to revive. Likewise, if the
property was later returned for additional repairs or for storage, it
was impossible to "tack" the two accounts. A new lien arose to
secure only the later bill. In general, it may be said that this com-
mon-law lien, with these same limitations, still exists. By statute,
however, many states now permit the lienholder to surrender pos-
session and still retain his lien for a limited time, provided a notice
of lien is filed.
Sec. 5. Foreclosure. At common law the only right of the
lienholder was to retain possession of the property. If he desired
to collect his charges, he was compelled to obtain a judgment and
levy against the property, just as any other creditor was required to
do. Because he retained possession of the property, his rights as a
creditor were superior to those of other creditors. Here, again, leg-
islation has generally changed the common-law rule and the lien-
holder is permitted to have the property sold for his benefit, any
surplus reverting to the owner of the property.
Sec. 6. Nature. A pledge consists of a bailment of property by
the owner to another as security for a debt. Attention should be
focused upon the fact that the lien does not arise until the pledgee
one who receives the property has actually taken the property
into his possession. 3 If the property is of such a nature that actual
physical possession is practically impossible, the pledgee may ac-
quire constructive possession of it by taking steps of some kind to
make it possible for third parties to learn of his interest in the prop-
erty. Thus, crude oil or gasoline contained in a huge tank could
not well be physically transferred from the pledgor to the pledgee,
but constructive possession could be obtained if the pledgee placed
an agent in charge of it, or if he leased the tank and posted on it no-
tices of his lease or lien.
Any surrender of possession by the pledgee, even temporary, ef-
fects a release of the security during the period in which the owner
is entrusted with the property. Any sale by the owner to an in-
3 Abraham Heilbron et al. v. Guarantee Loan & Trust Co, 1896, 13 Wash. 645, 43
Pac. 932; p. 761.
346 SECURITY FOR CREDIT TRANSACTIONS
nocent purchaser during such a period passes good title to the pur-
chaser and thus defeats the security of the pledgee.
Although any kind of personal property may be pledged, usually
a lien on tangible property is created by a mortgage. Therefore,
notes, bonds, certificates of stock, and other evidences of property
right, usually designated as collateral security, form the basis of
most pledges. Mere delivery of such property is sufficient to cre-
ate the lien, without any necessity for indorsement. Whenever ne-
gotiable instruments are concerned, the security of the pledgee is
increased by an indorsement, as he then becomes a holder in due
course, thus holding the paper free from personal defenses. The
position of the pledgor is compromised, somewhat by indorsement,
in that he thus places it within the power of the pledgee to pass title
to third parties prior to default, although the right to do so does not
Ordinarily, the pledgee gets no better title to, or equity in, the
pledged property than the pledgor had when the pledge was cre-
ated. However, where negotiable or seminegotiable paper is bearer
in form or has been indorsed in blank by the owner, the one in pos-
session has power to pass better title than he possesses. Thus, an
agent in charge of an order bill of lading which has been indorsed
in blank may effectively pledge it to an innocent creditor.
Sec. 7. Increase in pledged property. Any natural increase in
the property pledged becomes part of the pledge and may be re-
tained by the pledgee as security. Thus, the pledgee becomes en-
titled to temporary possession of any natural increase in livestock,
interest on indebtedness, or dividends on stock. This increase must
be accounted for by the pledgee at the termination of the pledge.
Thus, a pledgee who holds negotiable notes as security is entitled to
collect interest as it falls due, but must account for it at the final
Sec. 8. Debts secured. Unless provided otherwise, it is clear
that pledged property secures only the debt for which the pledge is
created. The pledgee is not entitled to hold the property as secu-
rity for another debt unless there is an agreement to that effect. It
is customary business practice, however, for the collateral agree-
ment to provide that the collateral shall secure first the particular
debt and then other obligations due, to become due, thereafter cre-
ated in favor of, or acquired by, the payee. Where such terms ex-
ist, the pledgee may, after the original debt is paid, retain the
collateral to secure other obligations running in his favor. Occa-
sionally the agreement reads that the security is to protect the orig-
inal debt and other obligations in favor of the holder thereof. In
this case any person who holds the original indebtedness at its ma-
BAILMENTS AS SECURITY 347
turity may use the pledge to secure other obligations due him as
they mature. 4 In this connection, there is a distinct difference be-
tween holder and payee. If the right to hold the collateral as se-
curity for other debts rests in the payee, only the original payee can
so use it.
A pledgee who transfers the pledge to an indorsee of the princi-
pal debt is not responsible for the misconduct of the indorsee with
reference to the collateral. If the indorsee wrongfully disposes
of pledged property, the loss cannot be attributed to the original
pledgee. This is particularly true where the primary debt is ne-
gotiable in form, thus implying the right to negotiate it and trans-
fer the collateral to the new holder of the indebtedness.
Neither does the original pledgee guarantee the genuineness of
the collateral security to the indorsee of the principal debt. One
obtaining unenforceable collateral from the original pledgee has no
action against the latter because of that fact.
Sec. 9. Sale of pledged property. The pledgee has no right to
sell the pledged property until after maturity of the debt which the
property secures. Neither has he any right to repledge the prop-
erty as security for an obligation of his own, except as he pledges
the obligation which the property secures in the first instance.
Some notes provide that property pledged may be sold at any time
the pledgee deems himself insecure. In such a case, the pledgee
may sell the property at any time, provided he feels insecure.
The pledgee should not be permitted to profit by an improper
sale and repurchase of the property pledged. Should the pledgee
wrongfully sell the pledged property or repledge it without author-
ity, he is guilty of conversion. In such a case the pledgor has an
option of recovering the value of the property at the time of the
conversion, or its value at the time he first demands it, or he may
recover the property from the innocent purchaser unless negotiable
paper is involved. Thus, assuming a sale by the pledgee without
proper notice, the pledgor may recover the value of the property at
the time of the sale or at the time he learns of the sale and makes
demand for the property, whichever proves most profitable to him.
If he does not care to do either, he may bring suit to recover the
property from the purchaser at the sale, leaving the latter to bring
an action against the pledgee.
Unless notice and public sale are waived by the pledge agree-
ment, the pledgee, after default by the pledgor, must give both no-
tice to the pledgor and public notice, and must sell the property at
a public sale if he desires to realize upon the pledge. It is custom-
ary, however, to provide in the pledge agreement that the property
4 Foster v. Abrahams, 1925, (Cal. District Court of Appeal) 241 Pac. 274; p. 761.
348 SECURITY FOR CREDIT TRANSACTIONS
may be sold with or without notice, and at public or private sale.
Under such conditions the pledgor may find that his property has
been sold following default without his having received any notice.
Although the pledgee generally has the implied right, upon the
pledger's default, to dispose of pledged property, he does not have
such right in the case of a pledge consisting of short-term notes.
The pledgee may realize his pledge only by collection of the collat-
eral notes as they fall due, unless the agreement provides otherwise.
The loss that is likely to arise from a public sale of short-term notes
is so great that the right to sell them arises only where it is ex-
The pledgee is under no duty to dispose of the property pledged
as security with him, even though he is requested to do so by the
pledgor. 5 He may sit idly by and watch the security decline in
value without putting forth any effort to dispose of it, and still re-
cover from the pledgor on the debt. If the pledgor desires to avoid
such a loss, he should redeem the property or bring a buyer who is
willing to pay enough for the pledged property to extinguish the
debt which the property secures. The right of the pledgor to re-
deem arises at the maturity of the debt and continues until the
pledged property has been properly sold by the pledgee. The
pledgor cannot avoid a loss which results from a decline in ,the value
of the pledge before the principal obligation matures. The pledgee
may always hold his security until the debt falls due, unless the debt
is payable "on or before" a certain date. In this case the debtor
may pay it whenever he desires and demand the pledge.
The pledgee should take care not to alter the rights of the pledgor
in the pledged property. Pie has no right to extend time on pledged
notes, deposit bonds with a reorganization committee, or release se-
curity for pledged collateral without the consent of the pledgor.
The latter is the owner, and his interest can be divested only by a
sale of the property after default has taken place or by such other
procedure as the pledge agreement makes provision for.
Sec. 10. Surplus after sale. The pledgor may recover from the
pledgee any surplus arising from the sale of the property, over and
above the amount required to pay the debt. Any deficit which
arises from a sale of the property may be recovered by the pledgee
from the pledgor.
In case the pledgee sells the property before the debt matures,
any profit from the sale belongs to the pledgor. Thus, a pledgee of
stock in a corporation, who sells it when prices are high and repur-
chases it when they are lower but before the debt matures, makes a
profit which the pledgor may recover.
6 Minneapolis & N. Elevator Co. v. Betcher, 1889, 42 Minn. 210, 44 N.W. 5; p. 762.
BAILMENTS AS SECURITY 349
Sec. 11. Nature. A relatively new device, which is finding
general favor as an instrument for financing purchases by the re-
tailer, is the trust receipt transaction. The trust receipt indicates
that the entruster has advanced money to the trustee for the pur-
chase of goods, the goods being held in trust for the entruster until
the indebtedness is satisfied. It is made use of primarily where
some agency, usually not related to the manufacturer, is financing
purchases of rather expensive items of stock in trade and where
the chattel mortgage is an unsatisfactory instrument. The finance
company advances a large portion of the purchase price and accepts
the trust receipt as its security. The retailer, known as the trustee,
is generally authorized to sell the articles in the ordinary course of
trade, but at the time of sale an accounting of the proceeds, to the
extent of the loan, must be rendered to the finance company. The
lien of the entruster finance company extends to contract claims
and negotiable instruments received by the retailer in settlement of
credit sales. Thus, if a retailer sells an automobile to a consumer
and receives a negotiable note in settlement, the finance company
has a claim on the note. The note in such a case is substituted as
security in place of the automobile.
The trust receipt has not been used to protect old obligations, and
under the Uniform Trust Receipts Act, recently enacted by a sub-
stantial number of the states, it can be used only to protect some
third party who has advanced money with which to buy new stock
or has advanced it to pay for stock previously purchased but re-
maining on the floor. It is not essential under the uniform law for
the lender ever to have had the goods in his possession, the lien aris-
ing as soon as the loan is made against the particular property.
The trust receipt, in many respects, is like a chattel mortgage,
and in some states has been held to be such under the recording
laws, thus making the security ineffective unless the trust receipt
conforms to the law relating to mortgages and is properly recorded.
In some particulars it partakes of the characteristics of a consign-
ment, and in others it is similar to a conditional sale, but it resem-
bles the pledge most. It differs from a pledge mainly in that pos-
session is not required to protect the lender.
Sec. 12. Rights of purchaser. Since the entruster authorizes
the trustee to sell the goods held in trust as a means of obtaining
funds with which to liquidate the loan, a purchaser in the ordinary
course of business obtains good title. The entruster loses his claim
to the property but has a claim to any unpaid balance, provided
that the claim is made before the consumer pays the retailer. In
350 SECURITY FOR CREDIT TRANSACTIONS
such cases the consumer may assert any setoff or defense against the
entruster that he possesses against the trustee.
One who purchases other than in the usual course of business,
or who obtains a judgment against the trustee and seeks to levy
against the property, takes the goods subject to the equity of the
lender. 6 One who takes the goods in satisfaction of an old debt,
giving a release of the obligation, receives a defective title in that he
may have to surrender them to the entruster. To the extent that
he gives new consideration, in addition to the cancellation of the
old debt, his claim is superior.
The Uniform Act provides for filing a copy of a general contract,
under which the parties expect to operate, with the Secretary of
State. 7 If this is not done within thirty days after the loan is
made, the lien of the entruster is inferior to that of an intervening
creditor or purchaser not in the usual course of business. Once the
agreement is filed, the entruster is protected on all transactions oc-
curring during the following year, a new filing being required an-
nually. Most of the states do not require recording in order for the
entruster to protect himself.
Storage, processing, or transportation liens are superior to the
claim of the finance company. Since such liens are customarily
incurred in the regular course of business, the lender assumes these
risks at the time the loan is made.
Sec. 13. Rights of the entruster. In case the entruster fails to
obtain payment of the debt at maturity or finds the borrower in de-
fault on any other term of the contract, he may possess the goods.
The contract may legitimately provide many causes for posses-
sion by the lender, such as insolvency of the borrower, a judgment
against him by some third party, or a feeling of insecurity on the
part of the lender. After possession of the goods is taken by the
entruster, he may, under the Uniform Act, sell them at public auc-
tion and apply the proceeds on the indebtedness, any deficit re-
maining a claim against the borrower. Any expense of selling or
possessing the goods is added to the indebtedness. Where the Uni-
form Act has not been adopted, the contract makes provision for
the right to possess and resell the goods.
If the retailer has sold the goods arid has failed to account for the
proceeds, the lender may recover any identifiable proceeds or other
property acquired therewith, provided the proceeds are still in the
trustee's possession. 8 This is true, however, only if action is taken
d General Motors Acceptance Corporation v. Hupfer, 1925, 113 Neb. 228, 202 N.W.
627; p. 763.
7 Donn v. Auto Dealers Inv. Co., 1944, 385 111. 211; 52 N.E.(2) 695; p. 764.
Commercial Credit Co. v. Barney Motor Co., 1938, 10 Cal.(2) 718, 76 Pac.(2)
1181; p. 766.
BAILMENTS AS SECURITY 351
promptly, thus avoiding injury to innocent third parties. 9 The
Uniform Act goes beyond and provides for a preference in liquida-
tion in case the lender can show that the assets of the borrower have
been increased by the proceeds received from the sale, it being un-
necessary to identify particular proceeds.
Review Questions and Problems
1. A shipped B goods on consignment. They were to be sold at prices
established by A, and the consignee, J3, was to account at the end of each
week for the goods sold, less a certain amount for his commission. While
the goods were in B's possession, they were destroyed by fire. Who must
bear the loss, assuming that B exercised proper care?
2. A takes his car into B's garage for repairs. At that time there was
a properly recorded chattel mortgage on the car. A failed to pay either
the mortgage or the repair bill. Whose lien is superior?
3. What steps must the pledgee take before disposing of pledged prop-
erty? How may he avoid this procedure?
4. Is the pledgor or the pledgee entitled to the surplus arising from a
sale of pledged property? May the pledgor demand that the pledgee
sell the pledged goods after default?
5. A pledged ten bales of cotton as security for an indebtedness of $200
and any other obligations due, to become due, created, or hereafter to be
created, in favor of the payee. The payee of the obligation negotiated
it to // and transferred the collateral to him. At the time of A's bank-
ruptcy, H held an additional claim of $300 against A. Are both claims
secured by the cotton?
6. One who has a lien upon an automobile for repairs surrenders pos-
session of it to the owner. What happens to the lien under the common
law? Has the result been changed by statute?
7. If A consigns to B goods for resale, may J5's creditors levy upon the
8. A loaned money to J3, a retailer, with which to purchase automo-
biles for resale. As security for the loan, A accepted a note from B and
a trust receipt for the cars. B sold one of the cars in the regular course
of business on a conditional sale contract, the conditional sale contract
and accompanying note being sold to a local bank. As between A and
the bank, whose claim to the note is superior?
9. P placed a diamond necklace in the hands of a jeweler in order that
the latter might show it to a prospective purchaser. Instead of selling
it, the jeweler pledged the necklace to the defendant as security for a
loan of $1,000. Can P successfully replevin the necklace?