Assignment 5 Perfection: Filing System Issues and Perfection by Filing Reference: Understanding Chapters 4, 5.01, 5.02, 5.03, 5.04, 5.05, 9.02, 9.03, and 16.04[B][1] Assignment 5: Points of Emphasis Why does perfection matter? In what filing system(s) must a secured party give notice of its lien/security interest? How does the UCC s filing system and search process work? What are the consequences for a creditor if there are errors in a financing statement? Problem 1 Myers owes Putnam County Bank $500K Collateral: (1) Honda Valkyrie motorcycle; (2) Ducati motorcycle; (3) Andy Warhol painting Bank filed UCC-1 (financing statement) covering the motorcycles and the painting Myers defaulted, sold Valkyrie to Mitchell Bank wants to repossess the collateral. Can it do so? Ostensible Ownership Problem Nonpossessory SIs (such as Bank s SI in Myers s motorcycles and painting in Problem 1) create an ostensible ownership problem Bank has a valid SI in the motorcycles, BUT Myers (in possession of motorcycles) appears to have full ownership rights This could mislead third parties (buyers like Mitchell, or other creditors) who are unaware of Bank s SI 1
Perfection Perfection is the act of making a SI enforceable against 3rd parties An act of perfection establishes the priority of a SI relative to the rights of other creditors or buyers of the collateral Perfection typically requires secured party to cure the ostensible ownership problem (so that the SI is no longer a secret lien) Perfection by Notification in the Public Records A secured party can sometimes perfect by taking possession of the collateral, but this is usually impractical The preferable approach is to have a secured party give notice by placing evidence of its claim in a public record (where 3rd parties can search and discover it) Perfection by Filing Under Article 9, the default method to perfect a SI is to file a financing statement [UCC-1] naming the debtor and describing the collateral Filing is required [ 9-310(a)], unless (1) Article 9 does not apply; or (2) Article 9 allows another method of perfection [ 9-310(b)] 9-521(a) specifies the form for a UCC-1 2
Myers Gary 123 Oak Street Columbia MO 65203 Putnam County Bank 5 Main Street Putnam MO 68999 2013 Honda Valkyrie motorcycle 2012 Ducati Monster 1200 motorcycle Andy Warhol painting, Ho Chi Minh Ordinary Collateral For most forms of tangible collateral, there are no public records that confirm ownership Possession is best evidence of ownership For them, perfection by UCC-1 filing suffices For some forms of collateral, the government does certify ownership, as with titled vehicles For these forms of collateral, perfection must occur within the title certification system (where persons would be looking for relevant title information) Titled Vehicles Each state issues title certificates for vehicles that provide government certification of ownership claims Covered in ALL states: cars, trucks, motorcycles (but NOT tractors or farm machinery) Covered in some states (but not all): boats, ATVs A secured party must perfect a SI in a titled vehicle by complying w/ state s certificate of title act [ 9-311(b)] This means the secured party must apply to the appropriate governmental titling agency to have its SI noted on the title certificate Generally, filing a UCC-1 does not perfect a SI in a titled vehicle [ 9-311(a)(2)] Problem 1: Result Painting is ordinary (nontitled) goods, so Bank s filing of UCC-1 financing statement was sufficient to perfect Bank s SI in the painting [ 9-308(a), 9-310(a)] Because motorcycles are titled goods, however, Bank s UCC-1 filings were ineffective [ 9-311(b)]; thus, Bank s SI in the bikes was unperfected (no act of perfection had occurred) [ 9-308(a)] What s the consequence of this for the Bank? 3
Which Statement Is True? A. Bank can sell the Ducati, and can repo the Valkyrie from Mitchell B. Bank can t sell the Ducati, and can t repo the Valkyrie C. Bank can sell the Ducati, but it cannot repo the Valkyrie Problem 1 Result Bank cannot repossess the Valkyrie from Mitchell, assuming that Mitchell didn t know of Bank s SI in the bike Rule: a buyer who pays value and takes possession of collateral, w/out knowledge of a SI and before that SI is perfected, takes free of that SI [ 9-317(b)] If Bank had perfected its SI before Mitchell bought the bike, Mitchell would ve taken the bike subject to Bank s SI [ 9-201(a), 9-315(a)(1)] Problem 1 Result Even though Bank has not yet perfected its SI in the Ducati, it can still repossess it from Myers and sell it based on Myers s default Upon attachment, security interest is enforceable against the debtor, whether or not it is perfected [ 9-201(a)] Perfection is irrelevant as between Bank and Myers; only attachment matters What if Myers filed a bankruptcy petition? Does that change your analysis? Bankruptcy law gives the trustee the status of a lien creditor under state law [BC 544(a)] Lien creditor takes priority over unperfected security interests [ 9-317(a)(2)] Thus, Bank would no longer be able to sell the Ducati; instead, Myers s bankruptcy trustee could set aside ( void ) Bank s SI and could recover possession of the Ducati [ 544(a), 542(a)] 4
Where Does Secured Party Perfect? There is no unitary national system for perfecting liens and security interests Each state has its own filing/perfection systems Thus, you must first determine what jurisdiction s law governs perfection of a SI; this determines The jurisdiction in which a creditor must file to perfect The jurisdiction where 3d parties would search for filing information Problem 2 First Bank plans to extend a $5 million line of credit to Royce-Rolls Motors, Inc. Royce-Rolls will operate two dealerships: one in E. St. Louis, IL and one in St. Louis, MO Repayment of the line of credit is to be secured by a SI in all of the vehicles on both sales lots How, and where, would you perfect the SI in the vehicles on these two sales lots? Titled Vehicles: Exception While a debtor holds motor vehicles for sale or lease, the 9-311(b) exclusion does not apply [ 9-311(d)] Thus, for cars that are inventory in the hands of Royce-Rolls Motors, First Bank would perfect by filing a UCC-1 covering inventory Rationale: Debtor only holds the cars temporarily Getting a COT for each car in name of Royce-Rolls Motors is unwarranted expense when buyers will have to get new COT when cars are sold So where does First Bank file a UCC-1? For regular goods, perfection of a SI is governed by the law of the state where the Debtor is located [ 9-301(1)], not where collateral is located! As an corporation, Royce-Rolls Motors is located in its state of organization [ 9-307(e)], even if it doesn t carry on business activity there If Royce-Rolls Motors, Inc. is organized under Delaware law (as many corporations are), First Bank would have to file a UCC-1 in Delaware to perfect the SI (even if the car lots were in Illinois and Missouri) 5
Perfection: Registered Organizations Why use the Debtor s state of organization rather than the state where Debtor does business, or where the collateral is physically located? Predictability and efficiency Debtor can do business in multiple states, and can move collateral from state to state, but the Debtor s state of organization remains constant, and can be readily confirmed in the public records (making it easier for creditors to search and file) Problem 2: Royce-Rolls Motors, Inc. is a registered organization [ 9-102(a)(71)] It is formed under the law of a single state by the filing of a public organic record [ 9-102(a)(68)] Available to public for inspection, confirms formation, existence, and identity of registered organization If Royce-Rolls Motors, Inc. is organized under Delaware law: 9-301(1): perfection of SI in the inventory will be governed by state of debtor s location 9-307(e): registered organization is located in state where it is organized First Bank would have to file UCC-1 in Delaware Once First Bank determines the appropriate state (DE), you perfect in that state by filing in that state s central filing office [ 9-501(a)(2)] E.g., in DE, this is the Division of Corporations In MO, this would be the Secretary of State Exception: if the collateral is land-related (e.g., growing timber or fixtures), the secured party would instead file the UCC-1 in the local (county) recorder of deeds office [ 9-501(a)(1)] Assume First Bank files a UCC-1 covering all of the inventory of Royce-Rolls Motors, Inc., in the correct filing office in Delaware Is that sufficient to perfect First Bank s SI in ALL of the Debtor s vehicles? Some vehicles may not be inventory E.g., loaner vehicles (used by customers) or shuttle vans (used by the service department) These would be equipment in which case they re covered by the state certificate of title statute; SI in each such vehicle must be perfected by having lien noted on title certificate for vehicle! 6
Choice of Law: Titled Goods Perfection of a SI in a titled good is governed by local law of the jurisdiction under whose certificate of title the goods are covered [ 9-303(c)] If the shuttle van is already covered by a title certificate issued by MO, First Bank could apply to MO (Dept. of Revenue) to have its lien noted on the title certificate for the van In MO, perfection occurs at time application + fee are delivered [RSMo. 301.600(2)] What if a car is on the lot for sale, but it is also used as a loaner? Belt and suspenders approach, i.e., First Bank could both (1) file a UCC- 1 against inventory, and (2) have its lien noted on the title certificates for that vehicle (to be safe) Problem 2 Due Diligence and Search When considering a secured loan, lender typically wants assurance that it will have a first priority security interest in the intended collateral Thus, lender must review records in the appropriate filing office(s) to determine whether other creditors have already made filings against the debtor that cover the intended collateral Filings are indexed in debtor s name to facilitate search Searching and Search Requests UCC-1s are indexed under debtor s name, so that searchers can search w/out filing officer s help However, searcher can also make an official search request of the filing officer [ 9-523(c)] Filing officer must provide certified copies of all UCC- 1s on file against the debtor, w/in 2 business days of receiving the search request [ 9-523(e)] (fee charged) Search results provides evidentiary proof of those filings a search would have revealed 7
Problem 3 The CLE you re watching gives Four Steps to Assure Perfection and Priority. They are: (1) Search the UCC records to confirm no prior filings exist against the debtor covering the intended collateral (2) If the search comes up clean, then file a UCC-1 covering the intended collateral (3) Then have the debtor sign the security agreement (if the debtor hasn t done so already) (4) Then, you can disburse the loan proceeds to the debtor and be assured of first priority Is this appropriate advice? There can be a gap between when a UCC-1 (1) is filed by a secured party and (2) is actually indexed by the filing officer Filing = tender of financing statement + filing fee [ 9-516(a)] Authorized UCC-1 is effective upon filing [ 9-510(a)] But, filing officer must index the filing to make it discoverable by searcher [ 9-519(a)] Indexing Delays and The Basket During this gap, a filed UCC-1 is effective to perfect a SI, but a searcher wouldn t be able to find it! During this time, a filed UCC-1 is said to be in the basket Note: filing officer has up to 2 business days to index a filed financing statement! [ 9-519(h)] Indexing Delays and The Basket Creditor Y s Nightmare Scenario Creditor X files financing statement Tuesday 10am Creditor Y gets clean search report Wednesday 1pm Creditor Y files financing statement Wednesday 2pm Thursday 8am Filing officer indexes Creditor X s financing statement 8
The correct sequence for Lender: (1) file a UCC-1 first; (2) wait until filing officer has indexed it; (3) THEN search for other filings Filing will stake out Lender s priority vs. other creditors as of time of filing [ 9-322(a)(1)] If search reveals another creditor made a prior filing, Lender can decide not to make the loan If Lender s search reveals only Lender s own filed UCC-1 (and no other filings), then Lender can reasonably expect to have first priority against the collateral Technology Most filing offices now authorize electronic filing (e-filing) of UCC-1s An e-filed UCC-1 can be automatically and instantaneously indexed (eliminating the gap problem) Until e-filing becomes universal, however, the gap problem remains Problem 4 Bank plans to extend $100,000 line of credit to Billiards on Broadway Intended collateral: all inventory, equipment, and accounts of debtor, including afteracquired Bank prepares UCC-1 as described in Problem 4. Is this sufficient? 9
Billiards on Broadway 514 E. Broadway Columbia MO 65201 34-2765185 Corporation Missouri Putnam County Bank 5 Broadway Putnam XX 21940 All of the Debtor s inventory, equipment, presently owned and after-acquired 9-502(a) [Sufficiency of financing statement.] Subject to subsection (b), a financing statement is sufficient only if it: (1) provides the name of the debtor; (2) provides the name of the secured party or a representative of the secured party; and (3) indicates the collateral covered by the financing statement. 9-503(a) [Sufficiency of debtor s name.] A financing statement sufficiently provides the name of the debtor: (1) if the debtor is a registered organization only if the financing statement provides the name that is stated to be the registered organization s name on the public organic record most recently filed with or issued or enacted by the registered organization s jurisdiction of organization which purports to state, amend, or restate the registered organization s name. 9-503(c) [Debtor s trade name insufficient.] A financing statement that provides only the debtor s trade name does not sufficiently provide the name of the debtor. Problem: UCC-1 does not reflect the debtor s correct name UCC-1 must be filed under the debtor s legal name [ 9-502(a)(1)] For a registered organization, debtor s name is the name that appears on the public organic records in the debtor s state of organization [ 9-503(a)(1)] Billiards on Broadway is a fictitious name or a trade name ; its real legal name is Broadway Supply Company [as confirmed w/ Mo. Sec. of State records] UCC-1 that contains only the debtor s trade name is not sufficient [ 9-503(c)] Why shouldn t Billiards on Broadway be a sufficient name, if that s the name the debtor uses in carrying on business? Certainty; business could have numerous trade names, but can have only 1 legal name Trade Names 10
Problem 4 Prudent prior creditors would have filed a UCC-1 using the name Broadway Supply Company Thus, Bank must search using that name A search under Billiards on Broadway would come up clean (no filings) But, a search under Broadway Supply Company would reveal a prior UCC-1 filing, covering the same collateral! Neighborly Finance took a security interest in the plumbing tools of Charley Graham (who has now filed for bankruptcy) Assume NF filed in Missouri, using the name Charley Graham Did NF properly perfect its SI in the plumbing tools? Problem 5 For nontitled goods, state of debtor s location controls question of perfection [ 9-301(1)] If debtor is an individual rather than a registered organization, individual debtor is deemed to be located in the state where debtor s principal residence is located [ 9-307(b)(1)] Thus, is Charley a resident of Missouri? If so, NF filed in the correct state If not, NF filed in the wrong state, and its UCC-1 would not be effective What if Charley had a home in Illinois and a home in Missouri? Q: Which is his principal residence? If court decides that was IL, filing in MO ineffective To hedge, NF could have filed UCC-1s in both states Problem 5 11
Suppose that Charley s only residence is in MO Was the MO UCC-1 filing (under the name Charley Graham ) sufficient to perfect NF s SI in the plumbing tools? Why or why not? Problem 5 Individual Names Problem: There is no public organic record [ 9-102(a)(68)] which provides a definitive legal name for individuals Contrast to registered organizations, where public organic record establishes their legal name (regardless of how they may hold themselves out to the public, i.e., trade name) 9-502(a) [Sufficiency of financing statement.] Subject to subsection (b), a financing statement is sufficient only if it: (1) provides the name of the debtor; (2) provides the name of the secured party or a representative of the secured party; and (3) indicates the collateral covered by the financing statement. 9-503(a) [Sufficiency of debtor s name.] A financing statement sufficiently provides the name of the debtor: (4) if the debtor is an individual to whom this State has issued a [driver s license] that has not expired, only if the financing statement provides the name of the individual which is indicated on the [driver s license]; (5) if the debtor is an individual to whom paragraph (4) does not apply, only if the financing statement provides the individual name of the debtor or the surname and first personal name of the debtor. [ALTERNATIVE A: THE ONLY IF RULE] If Charley has an active MO driver s license in the name Charles B. Graham, that s the name that the UCC-1 has to use to be clearly sufficient to satisfy 9-502(a)(1) NF s filing ( Charley Graham ) doesn t meet that standard, wouldn t be sufficient on its face If no active driver s license, then does the UCC-1 include his surname and first personal name? [Charles? Charley?] 12
Case Uncertainty: Individual Names Kinderknecht case (Kansas) is a good example of confusion in this regard Deere took SI in two farm implements belonging to debtor whose birth name was Terrance Joseph Kinderknecht, but who went by Terry Deere filed UCC-1 identifying the debtor as Terry J. Kinderknecht When Kinderknecht filed bankruptcy, the court held that the trustee could avoid Deere s SI [BC 544(a)(1)], b/c the UCC-1 didn t use the debtor s name, and Deere was thus unperfected! 9-506. Effect of Errors or Omissions (a) A financing statement substantially satisfying the requirements of this part is effective, even if it has minor errors or omissions, unless the errors or omissions make the financing statement seriously misleading. (b) Except as otherwise provided in subsection (c), a financing statement that fails sufficiently to provide the name of the debtor in accordance with Section 9-503(a) is seriously misleading. (c) If a search of the records of the filing office under the debtor s correct name, using the filing office s standard search logic, if any, would disclose a financing statement that fails sufficiently to provide the name of the debtor in accordance with Section 9-503(a), the name provided does not make the financing statement seriously misleading. Assume Charley is a resident of MO, so MO law governs perfection, and that name on his driver s license is Charles B. Graham Is NF s UCC-1 filing under name Charley Graham a seriously misleading error (i.e., NF s SI is unperfected), or is it a minor error, not seriously misleading (i.e., UCC-1 perfected NF s SI)? Problem 5 In a paper-based system, NF s filing under Charley Graham would likely be held a minor error Rationale: a prudent searcher would have found it in a search of paper records While the searcher might have noted the difference between Charles and Charley, the searcher might have noticed the similarity in the debtor s addresses and would ve investigated further (i.e., the error didn t compromise the ability of filing to give meaningful notice) 13
It depends on the filing office s search logic (at least with electronic-only searching) Would a search under the name Charles B. Graham reveal a UCC-1 filed under the name Charley Graham? If so (if system returns close matches), the error is not seriously misleading [ 9-506(a), (c)], and NF s SI would be perfected If not (if system returns only exact matches), the error is seriously misleading, so NF s SI would be unperfected [ 9-506(b), (c)] Search Logic Dilemma Should the filing system be set up to return close matches (i.e., any filing with the last name Graham and the first initial C or the first two letters Ch ) Or should it return only exact matches? IACA Search Logic Search Logic Dilemma Note: Flexibility has a cost for searchers: if search logic returns close matches, searches will produce more false positives (i.e., filings vs. other debtors with the last name Graham ) Searchers must investigate and exclude false positives, so the looser the search logic, the greater the potential search costs Does not distinguish case Disregards punctuation and accents Ignores Corp., Co., Inc., etc. Ignores the at beginning of a name Ignores spaces Treats an initial as = first or middle name beginning with that letter Treats no middle name = all middle names 14
Financing Statement: Required Information for Sufficiency 9-502(a): to be sufficient to perfect a security interest, UCC-1 must contain: The debtor s name The secured party s name (or the name of a representative of the secured party), and A description of the collateral covered by the financing statement... and Additional Information Filing officer can (and must) reject a financing statement if it does not include the following items of additional information [ 9-520(a), 9-516(b)], which are: Debtor s mailing address [ 9-516(b)(5)(A)] Secured party s mailing address [ 9-516(b)(4)] Whether debtor is an individual or an organization [ 9-516(b)(5)(B)] Properly rejected filing is not filed [ 9-516(b)] Why let the filing officer reject a filing that contains no address for the debtor, if a UCC-1 doesn t need that information to be sufficient to perfect under 9-502(a)? Idea: 9-516(b) information assists searchers in weeding out false positives, [ 9-520 comment 3] Filing Officer Rejection Trustee s Avoiding Powers Bankruptcy Code gives bankruptcy trustee the power to avoid any interests that could ve been avoided by a judgment lien creditor [ 544(a)(1)] U.C.C. 9-317(a): a lien creditor has priority over an unperfected SI Thus, in bankruptcy, trustee can avoid (invalidate) any unperfected SIs in debtor s property 15
Filed UCC-1 fails to provide an address for Putnam County Bank (secured party) Debtor (ABC, Inc.) later files bankruptcy. Can Trustee invalidate Bank s SI? No; if financing statement includes name of debtor and secured party, describes collateral, and is filed, it is effective to perfect SI [ 9-502(a), 9-520(c)] Problem 7(a) A. Yes B. No Omission of 9-516(b) Information If information required by 9-516(b) (e.g., address of secured party) is omitted, then filing officer MUST reject the filing [ 9-520(a)] However, if filing officer accepts it anyway (even though it should ve been rejected), the UCC-1 is sufficient to perfect a SI if it complies with 9-502(a) (e.g., it includes names of parties and description of collateral) [ 9-520(c)] 9-520(c) [When filed financing statement effective.] A filed financing statement satisfying Section 9-502(a) and (b) is effective, even if the filing office is required to refuse to accept it for filing under subsection (a). However, Section 9-338 applies to a filed financing statement providing information described in Section 9-516(b)(5) which is incorrect at the time the financing statement is filed. UCC-1 has an incorrect address for bankrupt Debtor Joseph Louis Thompson Can Trustee invalidate Bank s SI in the collateral? No; if UCC-1 includes name of debtor and secured party, describes collateral, and is filed, it is effective to perfect SI [ 9-520(c)] Problem 7(b) A. Yes B. No 16
9-338. Priority of Security Interest... Perfected by Filed Financing Statement Providing Certain Incorrect Information. If a security interest... is perfected by a filed financing statement providing information described in Section 9-516(b)(5) which is incorrect at the time the financing statement is filed: (1) the security interest... is subordinate to a conflicting perfected security interest in the collateral to the extent that the holder of the conflicting security interest gives value in reasonable reliance upon the incorrect information; and (2) a purchaser, other than a secured party, of the collateral takes free of the security interest... to the extent that, in reasonable reliance upon the incorrect information, the purchaser gives value and... receives delivery of the collateral. Error in debtor s address can actually compromise the filing system s operation Searcher looking at the UCC-1 might conclude (wrongly), based on bad address, that the UCC-1 in question covered a different Joseph Louis Thompson 9-338 would protect a purchaser who gave value in reasonable reliance upon the incorrect 9-516(b) information [ 9-520(c)] But, the bankruptcy trustee is a lien creditor [ 9-102(a)(52)], not a purchaser protected by 9-338 Problem 7: Mistakes in Filed UCC-1 Omitted address (secured party or debtor)? Does not defeat effectiveness (UCC-1 sufficient if it contains 9-502(a) info name of debtor, name of secured party, description of collateral) UCC-1 with missing address should be rejected [ 9-520(a)], but is nevertheless effective if wrongly accepted [ 9-520(c)] Problem 7: Mistakes in Filed UCC-1 Mistake in debtor s address? May defeat effectiveness vs. certain 3d parties If mistake reasonably could have, and actually did, mislead a third party into (a) buying the collateral or (b) taking a SI in it, that UCC-1 is not effective against the third party [ 9-338] Mistake doesn t affect effectiveness of UCC-1 as against lien creditors [ 9-520(c)] 17
Security agreement: Bank s collateral is all equipment and accounts, including after-acquired equipment UCC-1: collateral is equipment and accounts Can the Trustee invalidate Bank s SI under BC 544(a)? Problem 7(c) In Problem 7(c), the collateral description is sufficient UCC-1 sufficiently describes the collateral if it includes a description that satisfies 9-108 [ 9-504(1)] A generic description by UCC type reasonably identifies the collateral [ 9-108(b)(3)] UCC-1 covering equipment is effective to cover after-acquired equipment, even if after-acquired isn t expressly mentioned in the UCC-1 [ 9-502 cmt. 2] UCC-1 filed by Bank lists the collateral as all equipment and furniture located at 2001 Broadway, Putnam Security agreement: collateral is all equipment and furniture located at 251 First Avenue, Putnam Can Trustee invalidate Bank s SI? Problem 7(d) In Problem 7(d), Trustee can invalidate Bank s SI in the collateral, b/c it is unperfected Collateral description is necessary [ 9-502(a)] Error in description of collateral renders financing statement seriously misleading [ 9-506(a)] 3d party searcher would conclude that if Bank had a SI in equipment and furniture at the First Avenue location, it was not perfected by this UCC-1 Bank s SI is thus unperfected Compare: all Debtor s equipment (no location mentioned) 18
UCC-1 description: all of the debtor s assets Collateral: a particular computer system Is this UCC-1 sufficient? Yes; UCC-1 sufficiently describes the collateral if it covers all of the debtor s personal property [ 9-504(2)]; super-generic description is OK in a financing statement Problem 7(e) UCC-1 contains no collateral description at all (actual collateral = Debtor s equipment, inventory, and accounts) Is Bank s SI perfected? No; to be sufficient, UCC-1 must contain description of collateral [ 9-502(a)] Trustee can avoid Bank s SI Can Bank argue this a minor error that isn t seriously misleading? Problem 7(f) Filed but misindexed or unindexed UCC-1 is effective [ 9-517]. What does this mean for prospective buyers/lenders? Clean search isn t 100% assurance of priority Secured party that filed a misindexed UCC-1 has priority over secured party who got a clean search Misindexed Filings Should this risk be placed on filers, or searchers? Rationale for 9-517: filer shouldn t be responsible for mistakes of filing officer Filers are arguably better positioned than searchers to avoid this risk (check back) True electronic-only filing could eliminate this risk (but not here yet) Misindexed Filings 19