The American Law Institute (“ALI”) and National Conference of Commissioners on Uniform State Laws (“NCCUSL”) oversee the development of uniform laws for adoption by individual states to facilitate consistency between the various states’ laws, and commerce between them. Revised Article 9 of the Uniform Commercial Code (“UCC” or “Code”) represents the first major change since 1972 and has been sent to the states for adoption. Its implementation will require changes to documents and procedures used in secured transactions, as well as steps to maintain perfection of current security interests.
The Code governs many types of commercial transactions, and Article 9 governs security interests in certain types of personal property. Revised Article 9 provides changes in scope, substantive rules, and procedures, intending to bring greater certainty to financing transactions, reducing both transaction costs and the cost of credit, through two primary techniques: 1) Expanding the scope of property and transactions covered; and 2) Simplifying and clarifying the rules for creation, perfection, priority, and enforcement of a security interest to be as “user friendly” as possible. Revised Article 9 also recognizes emerging forms of electronic commerce, and clarifies consumer transaction rules (in some instances the compromise reached was to say nothing, leaving it to the courts or other state law). The Code as enacted in each state is similar but not identical, because there have been several Code versions, alternative provisions, and individual states typically make non-uniform changes. There are no provisions in the event Revised Article 9 is not enacted in all states by its effective date, which would complicate its already complex transition, requiring filing at both the location of the goods and the debtor’s location, and creating an issue in litigation as to which state law to apply.
Current filings generally remain perfected until the earlier of when they cease to be effective or June 30, 2006, and may be amended but not continued. Any time before a prior filing’s expiration (including before six months prior to expiration as in current continuation filings), an “initial filing” under Revised Article 9 (“in lieu filing”, which may include multiple current filings in one filing) must be made, identifying the prior filing and most recent continuation statement by filing office and numbers, if any, and indicate that the pre-effective date financing statement remains effective. It would be prudent to attach certified copies of prior filings to the in lieu filing to preserve evidence which may be needed later and would otherwise be unavailable. Changes to definitions and requirements for attachment and perfection, or a transfer or merger (see “double debtor”, below) may require earlier action, typically within four months or one year. Searches will be required in both the current and Revised Article 9 filing location (if different) for at least five years. Searches in other locations may still be required for liens and judgments even after five years.
The most noticeable change is that filings are made in the debtor’s “location”: The state of the debtor’s formation for entities created by a filing (e.g., corporations, including foreign entities whose country of origin has a similar entity filing system, otherwise Washington, D.C.); the chief executive office for entities not created by a filing (e.g., general partnerships); or an individual’s principal residence. Filings will be retained in filing office records until one year after they cease to be effective even if terminated, so filings no longer effective will show up in searches.
Financing statements must include the debtor’s correct name (fictitious names are disapproved) and are ineffective as a matter of law if a computer search (dependent upon the particular state filing office’s computer search logic, and a change in that search logic may make a previously sufficient filing ineffective absent amendment) under the debtor’s correct name does not turn up the financing statement with the incorrect name (courts no longer have discretion to determine an incorrect name is “close enough”). “Authorization” replaces signatures, and is deemed automatically consistent with the security agreement, facilitating electronic filing of financing statements and electronic searches. Express authorization (or subsequent ratification) is needed to pre-file a financing statement if the debtor has not “authenticated” a security agreement. Except in the case of certain consumer transactions, a security agreement’s and financing statement’s collateral description may use Code categories (e.g., “equipment”), and the financing statement, but not the security agreement, may use a generic statement (e.g., “all assets”) if authorized.
Categories of collateral
Categories of collateral for which a security interest can be perfected by filing are greatly expanded, including instruments and investment property (e.g., stock certificates, previously perfected only by possession), health care services insurance receivables, and existing (not after-acquired) “commercial tort claims” (which must be described with some specificity, e.g., “all claims arising out of the explosion at debtor’s fireworks factory July 4, 2001”). Special non-temporal priority rules for some types of collateral apply when one secured party perfects only by filing and another perfects by possession or control. A security agreement is a contract, and the expansion of Code definitions will not expand the property serving as security. The definition of “accounts” has been expanded to include payment obligations from sale, lease, or license of all kinds of tangible and intangible property (e.g., software license fees), and credit card receivables, but leaves some important kinds of payment rights within the “general intangible” definition (e.g., loan agreements not constituting “instruments”). “Payment intangibles” (the “principal” obligation is payment of money) and “promissory notes” (a subset of “instruments”, but not “order paper”, i.e., checks or drafts) are financing transactions and automatically perfected on sale (not for a security interest), permitting financial institutions to sell loan participations without having financing statements filed against them. “Supporting obligations” (e.g., guaranties and underlying collateral) follow the debt, and attachment and perfection of these follow the “supported obligation.” The first payment intangible buyer where there is nothing to possess always has priority, whereas a promissory note buyer relying on automatic perfection without taking possession will generally lose to a subsequent buyer (including a secured party) taking possession, but defeats a lien creditor, including a bankruptcy trustee. Collateral can have both purchase-money and non-purchase-money status, without losing its “purchase-money” character in certain circumstances, such as a refinancing of the purchase-money debt or having other collateral secure the purchase-money debt.
“Control” is a perfection method for: 1) Deposit accounts, 2) Letter-of-credit rights, and 3) Electronic chattel paper, and requires the securities intermediary’s or depository bank’s agreement to comply with the secured party’s entitlement orders without the debtor’s further “consent” (agreement not to exercise control rights until a subsequent event, e.g., debtor’s default, does not prevent present control). Control of electronic chattel paper requires a unique marking. Control of a letter-of-credit rights requires the issuer’s consent to assignment of proceeds, but this does not give the secured party the right to draw under the letter of credit. Perfection only by filing will not have priority over later control even with knowledge of the prior perfected security interest, but will defeat a lien creditor, including a bankruptcy trustee or debtor in possession. Security interests arising from sale of a promissory note are automatically perfected and have priority over lien creditors, including a bankruptcy trustee, but generally not over a subsequent secured party taking possession absent knowledge that it violates first secured party’s rights (more than just knowledge of existence). Two secured parties having control of investment property or a deposit account rank by temporal priority. Securities intermediaries as to security entitlements or securities accounts maintained with them, and depository banks as to deposit accounts maintained with them, obtaining a security interest, have automatic control for purposes of perfection and priority over a competing secured party. The same is true of the depository’s setoff rights.
“Double debtors” (e.g., collateral transfer and merger) are addressed, and a security interest continues in transferred collateral, but a new filing is required in the proper jurisdiction within one year if the new debtor “location” is different, and within four months unless the new debtor’s name is sufficiently close to the original debtor’s name to pass the computerized “seriously misleading” test. In addition to notice, bailees must acknowledge they hold the collateral “for secured party’s benefit.” Licensees under a nonexclusive license in ordinary course take free of a security interest created by their immediate (but not remote) licensor and continue their rights following foreclosure so long as licensee performs its obligations under the license.
Junior secured parties
Junior secured parties may collect checks another secured party has a prior security interest in and will prevail if they can establish “holder in due course” status (difficult or impossible if it has notice of the senior claim). Junior secured parties perfecting by possession may have priority over prior secured parties perfected only by a method other than possession. If the debtor collects accounts and then transfers money (in cash or by debtor’s check), the transferee takes free of a security interest unless acting in collusion with the debtor to violate the rights of the secured party.
Secured parties must give enforcement notices to other secured parties as well as the debtor, and guarantors are entitled to the same notices and protections as the debtor and may not waive those rights before default if the debtor could not waive them. Failure to meet the notice or “commercial reasonableness” requirements reduces the secured party’s deficiency to the extent the price obtained is affected (not applicable to a consumer transaction, but courts are “not [to] infer” anything from exclusion). Secured parties, persons related to secured parties, or guarantors purchasing collateral at a foreclosure sale for an amount less than a disposition to third parties would have brought reduces the secured party’s deficiency (secured party bidding at least the “strike price” they would credit bid with competitive bidding should avoid this). The secured party does not have to apply foreclosure sale non-cash proceeds (e.g., buyer’s note) to the debt until converted to cash, unless failure to do so is commercially unreasonable, and any application must be in a commercially reasonable manner, giving the secured party some flexibility in valuing non-cash proceeds and applying appropriate discounts. The secured party may retain collateral (including intangibles) in satisfaction (or, except consumer transactions, with debtor’s agreement partial satisfaction) of the debt even if not in possession, but the debtor can force a foreclosure sale. The secured party’s extended possession of collateral without disposition will not in constructive retention in full satisfaction of the debt.