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In last week’s blog, I mentioned that an Article 9 security interest in collateral may be either purchase money or non-purchase money. Let me now address the similarities and the differences.

First, both a purchase money security interest (PMSI) and a non-purchase money security interest (non-PMSI) give a creditor “rights” in collateral pledged to the creditor by the debtor to secure repayment of the debtor’s obligation to the creditor.     That is, they both make the collateral that is the subject of the PMSI or the non-PMSI subject to being taken by the creditor in the event of the debtor’s default in payment. In the event of default, a creditor may repossess the collateral via self-help, and sell the collateral at a statutory repossession sale in order to help it recover the amount owed.  All of this can be accomplished as a matter of statutory law without judicial process.

The major difference between a PMSI and a non-PMSI is the manner in which the debtor acquires the collateral.  If the debtor already owns the collateral that is pledged to the creditor, then the creditor’s interest in the collateral is a non-PMSI.  If, however, the collateral is acquired by the debtor with the proceeds of the credit extended by the creditor to the debtor, then the creditor’s interest in the collateral is a PMSI.

So, what’s the big deal?  Well, in consumer transactions, as opposed to commercial transactions, there are really only two key differences that matter:

First, a creditor’s security interest in a PMSI transaction is “automatically” perfected. The creditor need take no other steps in order to perfect the interest.  This factor can be particularly important in the event of a debtor’s bankruptcy.  The creditor’s security interest in a non-PMSI transaction is not automatically perfected. (See here for the distinction between perfection and priority of a security interest.)

And, second, the FTC Trade Regulation Rule—Credit Practices—does not deem it an unfair credit practice to take a security interest in household goods that are acquired by the debtor in a PMSI transaction. Those same household goods that are already owned by the debtor and pledged to the creditor in a non-PMSI transaction are subject to the Credit Practices Rule. (See here for a discussion of household goods and the FTC Credit Practices Rule.)

These two differences are of real significance in consumer finance.