A lender that properly files a Uniform Commercial Code Financing Statement (financing statement) and obtains a UCC search showing no other filings may believe that its interest is safe from other claims. However, it is important to realize that there are a number of interests that may not show up in the UCC search obtained at the time of closing that will take priority over the lender’s security interest. The following is a brief description of some of these interests.1
Security Interest Perfected Under Prior Name. When a debtor changes its name, a financing statement filed using its prior name remains effective for collateral acquired by the debtor before the name change or within four months thereafter. To protect against this, a lender should determine all prior names of the debtor (such as through a review of corporate records) and obtain searches under all prior names.
Security Interest Perfected by Different Method. While lenders and practitioners often use the phrase “first to file” as shorthand when discussing priority, it is actually “first to perfect.” Security interests in certain types of collateral can be perfected by filing and by methods other than filing. For example, security interests in goods, instruments, and tangible chattel paper can be perfected by possession. If a security interest is perfected by a method other than filing prior to the lender’s filing, that existing security interest will have priority but will not show up in the UCC search. Also, although a security interest in investment property (securities, securities accounts, etc.) can be perfected by filing or by control, a security interest perfected by control takes priority over one perfected by filing regardless of which security interest was perfected first. If any of these types of assets are an important part of the collateral, additional investigation may be warranted to determine the possible existence and extent of security interests perfected by these methods.
Encumbrances Filed in Other Locations. Certain non-UCC encumbrances (some judgment liens, for example) are perfected by filing in a location different from the filing location under the UCC. If these encumbrances predate the lender’s UCC filing, they will be prior in right even though they do not show up in the UCC search obtained by the lender. A lender should work with experienced counsel to determine additional locations that should be searched. Also, the filing location under the UCC for certain types of debtors can be based on possibly indefinite facts. For example, the filing location for an individual with more than one residence is based on that person’s “primary residence,” and the filing location for certain types of organizations (including general partnerships) with more than one place of business is based on its “chief executive office.” Determining primary residence or chief executive office is not always clear and can change over time. Accordingly, under appropriate circumstances, it may be prudent to search and/or file in multiple jurisdictions.
Purchase Money Security Interest2 (PMSI). A PMSI can take priority over a prior perfected security interest in the same collateral. Although there are certain details and complexities, generally speaking, a PMSI in goods other than inventory has priority if it is perfected when the debtor receives possession of the goods or within 20 days thereafter. A PMSI in inventory has priority if it is perfected when the debtor receives possession and the holder of the conflicting security interest receives notice meeting certain requirements within five years before the debtor receives possession. Further complicating matters, a PMSI in consumer goods is perfected upon attachment without the need to file a financing statement.
Consignment. Depending on several factors, the lender’s security interest might not attach at all to inventory consigned to its borrower, or the security interest may attach but the consignor’s rights may have PMSI status if it takes appropriate steps to protect its position. This determination is fact dependent, and careful analysis should be conducted when the borrower is involved in selling the goods of others.
Lien Creditor (e.g., Attachment, Levy, Assignee for Benefit of Creditors, Receiver). A prior perfected security interest is subordinate to the rights of a person that becomes a lien creditor to the extent that the security interest secures an advance made more than 45 days after the person becomes a lien creditor unless the advance is made either (1) without knowledge of the lien or (2) according to a commitment entered into without knowledge of the lien.
Personal Property Taxes. In some states (Connecticut, for example), a lien for personal property taxes takes priority over a prior perfected security interest in that property. In these jurisdictions, a lender may, for example, require ongoing proof that personal property taxes are being paid.
IRS Liens. Depending on the nature of collateral and the type of loan, a federal tax lien can take priority over a prior perfected security interest. This is discussed in more detail in our prior alert, “Priority of Federal Tax Lien on Personal Property: Secured Lender vs. IRS.”
Perishable Agricultural Commodities Act (PACA). Under PACA, unpaid sellers of fresh fruits and vegetables have priority over a perfected security interest if the buyer/debtor becomes insolvent or files for bankruptcy. Additional analysis and specific loan document provisions should be considered if these types of products constitute a significant portion of the borrower’s assets.
Artwork. Some states (New York and Connecticut, for example) have statutes that give the artist that consigns their artwork to a dealer, and, in some cases the artist’s successors and others, rights senior to those of the dealer’s creditors (even one with a perfected security interest). The scope of this protection varies from state to state. A lender to an art dealer would be well advised to check for applicable statutes where the dealer and artwork is located before counting on consigned artwork as collateral.
There are a number of existing security interests and other encumbrances that often will not be revealed in a standard UCC search and are prior in right. There are also a number of subsequent liens that will be senior in priority to a previously perfected security interest. A careful lender must work with experienced counsel to perform the appropriate up-front analysis and take appropriate steps to avoid or minimize the impact of these interests or encumbrances on its collateral position.
The Thought Leadership Committee of Barclay Damon’s Restructuring, Bankruptcy & Creditors’ Rights Practice Area issues alerts and blogs on an ongoing basis to keep clients, colleagues, and friends up to date on important developments in the insolvency space. If you have any questions regarding the content of this alert, please contact the author, Robert Wonneberger, Thought Leadership Committee chair, at rwonneberger@barclaydamon.com, or Janice Grubin or Jeff Dove, Restructuring, Bankruptcy & Creditors’ Rights Practice Area co-chairs, at jgrubin@barclaydamon.com and jdove@barclaydamon.com.
1This alert discusses security interests in assets that can be perfected by filing. Types of collateral that must be perfected by a different method (including deposit accounts, money, and letter-of-credit rights) are outside the scope of this alert as are the effects of bankruptcy on the secured party’s position.
2Generally, a security interest in collateral securing an obligation incurred to acquire the collateral.