Service Area: UCC Services

UCC-1 Collateral Description Reference Security Agreement

Posted on November 30, 2018 by - In Other Commercial Credit News, UCC Financing Statements

What Happens When a UCC-1 Collateral Description References the Security Agreement, but the Security Agreement Isn’t Attached?

What happens to a security interest when the collateral description within the Financing Statement says, “see attached Security Agreement,” but the Security Agreement isn’t filed with the Financing Statement? The security interest is unperfected.

Sound familiar? Perhaps because we just reviewed a case a few weeks ago with a similar fate. While these two cases are different, the underlying similarity is failing to include additional documentation with the Financing Statement.

The Case: 180 Equipment, LLC v First Midwest Bank

$7,600,000 = the total owed to the Secured Party, according to the Secured Party’s proof of claim.

180 Equipment, LLC (180 Equipment) obtained a loan from First Midwest Bank (Bank) and granted Bank a security interest in 26 specifically identified “categories of collateral, including accounts, chattel paper, equipment, general intangibles, goods, instruments and inventory and all proceeds and products thereof.” 180 Equipment does not own any real property, so Bank’s security interest essentially covered all assets.

In its Financing Statement, Bank identified the collateral as “All Collateral described in First Amended and Restated Security Agreement dated March 9, 2015 between Debtor and Secured Party.” However, Bank did not include the Security Agreement with the filing of its Financing Statement.

When 180 Equipment filed for bankruptcy protection, the trustee argued that Bank’s security interest was unperfected because it failed to sufficiently describe the collateral. “The trustee… contends that the mere reference to the collateral as being described in the amended security agreement does not suffice to indicate, describe or reasonably identify any collateral.”

Bank argued the filing of the Financing Statement was enough to put other creditors on notice. “…the purpose behind the filing of a financing statement is merely to provide notice to third-party creditors that property of the debtor may be subject to a prior security interest, and that further inquiry may be necessary to determine the identity of the collateral.”

The court’s decision? The court agreed with the trustee. Bank’s Financing Statement failed to sufficiently identify the collateral. Referring to the Financing Statement, the court states “Rather, it attempts to incorporate by reference the description of collateral set forth in a separate document, not attached to the financing statement. The financing statement, on its face, provides no information whatsoever, and therefore no notice to any third party, as to which of the Debtor’s assets First Midwest is claiming a lien on, which is the primary function of a financing statement.”

Could safe harbor have saved Bank’s security interest?

“In accordance with section 9-504(2), which permits the use of a supergeneric description in a financing statement, [Bank] could have perfected its security interest by indicating its collateral in the financing statement as “all assets” or “all personal property.” The Uniform Commercial Code Comment to section 9-504 refers to the supergeneric description alternative as a “safe harbor” that “expands the class of sufficient collateral references” in order to accommodate the common practice of debtors granting a security interest in all or substantially all of their assets.”

A Failed Financing Statement

Despite Bank’s persistent efforts to argue the perfection of its security interest, the court deemed the security interest unperfected for failure to comply with the provisions under Article 9. After all, how can other creditors determine whether collateral is already subject to security interest, if they don’t have access to a description of the collateral.

“A financing statement that fails to contain any description of collateral fails to give the particularized kind of notice that is required of the financing statement as the starting point for further inquiry.”

Bonus: Warning to Private Equity Companies?

In an article by Deborah Enea of Pepper Hamilton LLP, Enea notes that private equity companies should heed lessons from this case.

The case provides important guidance to private equity companies, including:

– If a private equity company invests in a target as a secured creditor, the private equity company should avoid ambiguous collateral descriptions in its UCC-1 financing statements.

– Collateral descriptions in UCC-1 financing statements should include super-generic descriptions (such as “all assets of the debtor”) while avoiding reference to definitions in an underlying agreement.

– If collateral descriptions in UCC-1 financing statements refer to definitions in an underlying agreement, the underlying agreement must be attached to the financing statement.

Collateral Descriptions within Your UCC Financing Statement: Perfectly Imperfect

Posted on November 16, 2018 by - In Other Commercial Credit News, UCC Financing Statements

Perfectly Imperfect Collateral Descriptions within Your UCC Financing Statement: It’s a Delicate Balance.

A properly perfected security interest is nothing without a collateral description. In fact, it’s not properly perfected at all – it’s unperfected. A properly perfected security interest requires compliance with Article 9, which includes a Security Agreement and the subsequent filing of the UCC-1 Financing Statement.

Contents of a Security Agreement

What information should the Security Agreement contain? A Security Agreement should include the following:

  • The name & address of the debtor
    • The name for an organization must be the name as it appears in the public organic record
    • The name for an individual, depending on the state, should be the name as it appears on the unexpired driver’s license
  • A granting clause
  • A collateral description
  • Reference to governing law
  • The date of the agreement
  • Signatures from authorized individuals

Contents of the UCC Financing Statement

Article 9-502 clearly identifies the information that is to appear in the Financing Statement: the name of the debtor, the name of the secured party and the collateral description.

(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.

What Constitutes a Sufficient Collateral Description?

Article 9-108 provides the following:

(a) Except as otherwise provided… a description of personal or real property is sufficient, whether or not it is specific, if it reasonably identifies what is described.”

(b) [Examples of reasonable identification.]

Except as otherwise provided in subsection (d), a description of collateral reasonably identifies the collateral if it identifies the collateral by:

(1) specific listing;

(2) category;

(3) except as otherwise provided in subsection (e), a type of collateral defined in [the Uniform Commercial Code];

(4) quantity;

(5) computational or allocational formula or procedure; or

(6) except as otherwise provided in subsection (c), any other method, if the identity of the collateral is objectively determinable.

Be careful, there’s a fine line between being too specific and too generic.

Can I Attach My Collateral Description as an Exhibit to the UCC Filing?

Yes, you could attach an exhibit to your filing. But… just because you can, doesn’t mean you should. Authors from Troutman Sanders LLP explained in their recent article UCC Incorporation by Reference: An Imperfect Way to Perfect: “Generally, a UCC-1 financing statement’s collateral description is sufficiently descriptive when it refers to details provided in an attachment.” And, they further stated “a collateral description that refers to an unattached, lapsed financing statement may be sufficient when the UCC-1 includes the financing statement’s filing number.”

However, a bankruptcy court recently deemed a security interest unperfected, because the document which identified the collateral was not available at the local clerk’s office (interestingly, it was available on other websites – just not the local clerk’s). According to the authors, the court “held that a UCC-1 financing statement is ineffective to perfect a security interest if the public document to which its collateral description referred is not available at the local clerk’s office where UCC records are maintained.”

A Bit of Background

The debtor issued bonds pursuant to a “pension funding bond resolution.” The debtor & secured parties executed Security Agreements accordingly. The resolution was posted publicly online and provided the pledged property in detail, but did not provide a description of the collateral.

The bond holders filed UCC-1s to properly perfect their security interest, and within the UCC-1 they described the collateral as the “pledged property described in the Security Agreement attached as Exhibit A hereto and by this reference made part hereof.” The UCC was then filed with a copy of the Security Agreement, although, it did not include the separate resolution that identified the collateral.

So, what’s the problem? Without the resolution document, “an interested third party reading the financing statement and the attached security agreement would know to look for the resolution to find a detailed description of the collateral but would not be able to find the resolution at… the applicable financing statement filing office.” The court further noted it would be out of scope to have an interested third party tracking down a document — even if it is just a matter of going to a different website.

Be Careful, Because Perfect Can Quickly Be Imperfect

UCC filings can be quite precarious. Again, there is a fine line between a collateral description that is too specific or one that is too generic.  Just as it is debatable whether a court will uphold a security interest as perfected if the collateral is identified within an exhibit. Be careful, be thorough, don’t take short cuts and always review.

Parting thoughts from Troutman Sanders LLP:

“Although this bright-line rule tightens court oversight of the incorporation by reference doctrine, it provides needed clarity moving forward for practitioners — particularly those looking to save a bit of work or time by not including a full collateral description on the financing statement itself. Lenders should refrain from drafting collateral descriptions that rely on extrinsic documents, especially when the referenced document is not attached as an exhibit to the financing statement. Lenders should take particular care when using collateral descriptions that contain terms that are defined in nonpublicly available documents, such as credit agreements and security agreements, if those documents are not attached to the financing statement, and this decision suggests that financing statements may be insufficient to perfect if not all applicable defined terms are specifically included on the financing statement itself or on an exhibit annexed to the financing statement. Lenders should ensure that interested third parties can sufficiently identify the covered collateral without having to take additional steps in the search process. If further sleuthing is needed, the UCC-1, and the drafting skills of its scribe, may be deemed imperfect.”

Arbitration is Alternative Dispute Resolution

Posted on October 12, 2018 by - Credit Risk Management, In Other Commercial Credit News

Dispute Resolution Alternative: What is Arbitration?

Arbitration, like mediation and adjudication, is a form of alternative dispute resolution and is typically favored in lieu of litigation. Generally, in arbitration an impartial third party listens to each side of the dispute and makes a decision resolving the dispute.

It’s important not to confuse arbitration with mediation, which, admittedly, I initially did. The American Bar Association notes “Arbitration is different from mediation because the neutral arbitrator has the authority to make a decision about the dispute.” In mediation, the third party is present to facilitate the conversation, rather than offer resolution.

The American Arbitration Association explains arbitration as “A private, informal process by which all parties agree, in writing, to submit their disputes to one or more impartial persons authorized to resolve the controversy by rendering a final and binding award.”

In most contracts, construction & otherwise, you will find an arbitration clause. On its website, American Arbitration Association provides visitors with the following standard construction arbitration clause.

“Any controversy or claim arising out of or relating to this contract, or the breach thereof, shall be settled by arbitration administered by the American Arbitration Association under its Construction Industry Arbitration Rules, and judgment on the award rendered by the arbitrator(s) may be entered in any court having jurisdiction thereof.”

Clause is Present, Suit Dispute

Despite the presence of an arbitration clause within a contract, one or more parties involved in a dispute may file a lawsuit. Once a lawsuit has been filed, someone may file a motion to dismiss the lawsuit, based on the arbitration clause within the contract. However, according to a recent article by Robert Cox of Williams Mullen, once the court is involved, it’s up to a judge to determine whether the dispute should be arbitrated by the court or by an arbitrator.

“A court resolving an arbitrability dispute must engage in a two-step inquiry… First, the court must determine who decides whether a particular dispute is arbitrable – an arbitrator or the court. Second, if the court determines that it is the proper forum to adjudicate the arbitrability of the dispute, then the court must decide whether the dispute is in fact arbitrable.”

Cox goes on to say a dispute is suited for the courts unless the language within the contract “clearly and unmistakably provides that the arbitrator shall determine what disputes the parties agreed to arbitrate.” Further, according to Cox, courts have frequently determined “… that incorporation of the American Arbitration Association’s (AAA) arbitration rules constitutes clear and unmistakable evidence that the parties agreed to arbitrate arbitrability.”

When Arbitration Won’t Be Arbitrated, Arbitrarily

There may be circumstances when a judge will determine an arbitrator should not preside over a dispute. According to Cox, several U.S. Courts of Appeals have used a test called “wholly groundless” to determine whether arbitration is appropriate. What is “wholly groundless”? Essentially, if the claim is frivolous or deemed unlawful.

Parting Thoughts

There are many benefits to arbitration. Arbitration may be a faster and less expensive process than formal litigation; plus, in binding decisions, an arbitrator’s decision will be upheld by courts.

I admit, the arbitration clauses are a bit foreign to me, but I found The AAA Guide to Drafting Alternative Dispute Resolution Clauses for Construction Contracts, published by American Arbitration Association to be quite insightful. It appears American Arbitration Association maintains an industry standard for arbitration clauses, though as a best practice you should seek legal guidance when drafting and/or signing an agreement.

UCC Filings, Key Words and Common Terms

Posted on October 8, 2018 by - UCC Financing Statements

A Review of Key Words and Common Terms Related to UCC Filings

In the spirit of “back-to-school,” today’s post is a UCC Article 9 vocabulary lesson. Break out your pencils and notebooks, let’s get started!

What is a Financing Statement?

Under Article 9 of the Uniform Commercial Code (UCC), a Financing Statement is a statement identifying a security interest in specific collateral. The Financing Statement is filed to provide notice to other creditors of a security interest.

Security Agreements, Collateral, Ship Date & Assignment

  • Security Agreement: An authenticated agreement that creates or provides a security interest. Agreement must include the date, debtor’s legal name, address, authentication, granting clause, collateral description and default terms.
  • Collateral: Assets or property used to secure a loan or other credit. Collateral becomes subject to seizure on default.
  • Equipment Ship Date: To achieve priority status with respect to a Purchase Money Security Interest in collateral deemed “equipment”. A Financing Statement must be filed before, or within 20 days after, the debtor receives delivery of the collateral. The security interest will take priority over the rights of a buyer, lessee, or lien creditor.
  • Assignment: An initial UCC-1 Financing Statement may reflect an assignment of all the secured party’s power to the Financing Statement by providing the name and mailing address of the assignee as the name and address of the secured party. A secured party may also assign of record all or part of its power to an already recorded filing by filing an Assignment Statement which provides the name and mailing address of the assignee (9-514).

UCC Forms

  • UCC-1 Initial Financing Statement: Original recorded document that identifies the initial filing number, date, time, debtor, secured party and collateral description.
  • UCC-3:
    • Continuation: A continuation statement continues the effectiveness of a filing for a period of 5 years. It may be filed only within the six months immediately before lapse.
    • Change Statement: A statement that makes a change to the original UCC-1 Financing Statement through either an amendment, continuation, assignment or termination.
    • Termination: The filing of a termination statement ceases the effectiveness of the original UCC-1 Financing Statement to which it identifies (9-513).
  • UCC-11: An informational search to determine whether there are other secured parties, whether specific collateral is already secured by a UCC and to determine a creditor’s priority

What are the Types of Security Interests?

Agricultural Lien: Agricultural lien means an interest, other than a security interest, in farm products: (A) which secures payment or performance of an obligation for; (B) which is created by statute in favor of a person; (C) whose effectiveness does not depend on the person’s possession of the personal property.

Bailment: A “true” consignment is a Bailment (for the purpose of the sale). *To meet the requirements of Article 9 – record the UCC-1 Financing Statement (bailor/bailee) and send notification letters to the prior secured creditors.

Blanket: A security interest in all assets of the debtor. *Record the UCC-1 Financing Statement – search & notification letters are not required.

Consignment – 9-102(20): “Consignment” means a transaction, regardless of its form, in which a person delivers goods to a merchant for the purpose of sale. If a transaction is a “sale or return” it is NOT a consignment because the buyer becomes the owner of the goods and the seller may obtain an enforceable security interest in the goods. *To meet the requirements of Article 9, a consignment is treated the same as a Purchase Money Security Interest in Inventory – record the UCC-1 Financing Statement (consignor/consignee) and send notification letters to the prior secured creditors.

Fixture Filing/Real Estate Filing – 9-102(40): “Fixture Filing” means the filing of a financing statement covering goods that are or are to become fixtures. (9-102(41)) “Fixtures” means goods that have become so related to particular real property that an interest in them arises under real property law. * To meet requirements of Article 9 – Record the UCC-1 Financing Statement with a legal description of the property in the COUNTY where mortgages are recorded (9-501(a)(1)(B)).

Lease: A true lease is automatically perfected under Article 2A. A filing is not needed. However, occasionally doubts arise concerning whether a transaction creates a relationship to which Article 9 or its filing provisions apply. For example, questions may arise whether a “lease” of equipment in fact creates a security interest. *In this case a UCC-1 Financing Statement will be recorded listing the equipment – in case the “lease” is construed to be a security interest.

Notification Filing: UCC-1 Financing Statement that is recorded to “notify” secured creditors of a business transaction regarding certain collateral. This does not create a security interest that secures an obligation. *Record the UCC-1 Financing Statement – search and notification letters are usually sent to alert prior secured creditors.

Promissory Note: A signed document containing an unconditional promise to pay specified funds to another party by a specified date.

Purchase Money Security Interest in Equipment (aka PMSI): Securing collateral that is defined as equipment (9-102(33)) – “Equipment” means goods other than inventory, farm products, or consumer goods. The “equipment” is used in the course of the debtor’s business – it is not stocked. *To achieve priority in equipment the UCC-1 Financing Statement must be recorded within 20 days of debtor receipt.

Purchase Money Security Interest in Inventory (aka PMSI): Securing collateral that is defined as inventory (9-102(48)) – “Inventory” means goods, other than farm products, which: (A) are leased by a person as lessor; (B) are held by a person for sale or lease or to be furnished under a contract of service; (C) are furnished by a person under a contract of service; or (D) consist of raw materials, work in process, or materials used or consumed in a business. *To achieve priority in the inventory the UCC-1 Financing Statement must be recorded and notification letters (authenticated) sent before shipping.

Tooling: A supplier has possession of tooling or other equipment that is owned by the buyer. UCC-1 Financing Statement is recorded to “notify” secured creditors of a business transaction regarding certain collateral. This does not create a security interest that secures an obligation. *Record the UCC-1 Financing Statement – search and notification letters are usually sent to alert prior secured creditors.

Warehousing: UCC-1 Financing Statement that is recorded to “notify” secured creditors of a business transaction regarding certain collateral. This does not create a security interest that secures an obligation. *Record the UCC-1 Financing Statement – search and notification letters are usually sent to alert prior secured creditors.

Pop Quiz

Just kidding! No pop quizzes today. However, if you have questions, please don’t hesitate to contact us!

Customer’s Name Change Could Jeopardize Your Security Interest

Posted on September 17, 2018 by - Credit Risk Management, UCC Financing Statements

Be Careful, Your Security Interest May Be in Jeopardy if Your Customer’s Name Changes

The accuracy of critical data within your UCC Financing Statement can make or break your security interest. Unfortunately, one critical piece of data can change quickly and even worse, it can easily go unnoticed: a change in your customer’s name.

Names change, it happens.

Perhaps your customer is an individual and has recently married or divorced, or maybe your customer has opted to change its corporation’s name based on brand recognition. Whatever the reason, names change and if you have filed a UCC to properly perfect your security interest, you may need to take swift action to ensure your security interest remains perfected.

First, What Does Article § 9-503 Address

Article § 9-503 provides guidance on how to correctly identify your customer within the UCC Financing Statement.

In compliance with § 9-503, if your customer is a registered entity, your customer’s name must appear on the UCC exactly as it appears in the public organic record.

If your customer is an individual, first determine whether the state has implemented Alternative A or Alternative B:

Alternative A: if the debtor holds an unexpired driver’s license, the Financing Statement must list the debtor’s name as it appears on the unexpired driver’s license. (If the debtor does not have a driver’s license, the Financing Statement should list the “individual name” of the debtor or the debtor’s surname and first personal name.)

Alternative B: the debtor’s driver’s license name, the debtor’s actual name or the debtor’s surname and first personal name may be used on the Financing Statement.

Most states implemented Alternative A, which means your customer’s name must appear on the UCC exactly as it appears on his/her unexpired driver’s license.

OK, What Happens if My Customer’s Name Changes?

As a best practice, we recommend amending your UCC filing if your customer’s name changes. There may be situations where an amendment is not “required,” but it’s a risk to not amend. If you are unsure whether you want to amend your filing, I would recommend you determine whether the name change renders your filing as seriously misleading.

What is Seriously Misleading?

According to § 9-506 (b), a Financing Statement that “fails sufficiently to provide the name of the debtor in accordance with Section § 9-503 (a) is seriously misleading.” OK, succinct yet vague. How would you know whether the UCC sufficiently identifies your customer? Three words: Standard. Search. Logic.

“Standard Search Logic” is the holy grail of determining whether a filing is seriously misleading. Search logic is created, determined & managed through an algorithm – not entirely unlike a typical Google search, although a Google search is very flexible and the parameters for this search logic are narrower.

In 2015, International Association of Commercial Administrators (IACA) released the revised Model Administrative Rules, which include a specific section that is frequently referred to as “standard search logic.”

One rule for standard search logic is 503.1.2 “No distinction is made between upper and lower case letters.” This means that the debtor’s name could be entered as ABC COMPANY INC or ABC Company Inc, and both are acceptable.

Another rule addresses punctuation: 503.1.3 (b) “Punctuation marks and accents are disregarded. For the purposes of this rule, punctuation and accents include all characters other than the numerals 0 through 9 and the letters A through Z (in upper and lower case) of the English alphabet.”

IACA recognizes the general idea of “noise words”. Typically noise words include “and,” “the,” “inc” and “co.”  Although noise words are addressed in the Model Administrative Rules, the list of actual noise words are determined by each individual filing office. This difference by jurisdiction could mean that a filing that would not be seriously misleading in Virginia may be seriously misleading in Georgia, based on the individual search logics.

Like I said, risky. Which is why it may be in your best interest to set a standard business practice to amend a filing any time you encounter a customer name change.

You’ve Got 4 Months

Article 9 – 507(c) provides a 4 month window to amend the filing for a debtor name change that may be considered “seriously misleading.” If the change in your customer’s name makes the filed Financing Statement “seriously misleading,” UCC Section 9-507(c) states the Financing Statement will only be effective for collateral acquired prior to the name change or within four months following the change.

This rule applies even if the you have not received actual or constructive notice of the name change from your customer. You can prevent a UCC from becoming unperfected on collateral acquired beyond this 4 month window by filing an amendment to the Financing Statement with the new business name of your customer.

How Will I Know if The Name Has Changed?

Of course, there is the issue of knowing when your customer’s name changes. In a perfect world, your customer would notify you of name and address changes, but we certainly don’t live in a perfect world. NCS offers corporate monitoring and driver’s license monitoring, which provide alerts when there are changes in your customer’s name.

Prefer to manage it on your own? Create a schedule to periodically check the Secretary of State where your customer is registered or obtain a copy of the current driver’s license and review the information on incoming payments: bonus, the check may have the new name AND the new address.

Retail Bankruptcy and the Impact on the Landlord

Posted on August 24, 2018 by - Credit Risk Management, In Other Commercial Credit News

Bankruptcy, Bankruptcy Everywhere. Landlord, Landlord Have No Fear

Landlords are impacted by retail bankruptcy, too! The hot topic continues to be retail bankruptcies – with no signs of slowing down. We’ve previously discussed what retail bankruptcies mean for creditors who supply inventory, but what about the landlord? Most brick and mortar stores are leased by the retail entity; very few retailers own the building in which they are located.

Read on to learn more about what landlords can do to protect themselves in commercial bankruptcies.

Look Out for the Automatic Stay

The automatic stay is an injunction that stops any and all collection activity against the bankrupt entity and the automatic stay goes in to effect as soon as the bankruptcy petition is filed. The automatic stay impacts ALL creditors, whether supplying an inventory of board games or leasing the property to the bankrupt entity.

However, a landlord may have some remedies available, so long as the landlord seeks bankruptcy court approval first.

In an excellent article by Lars Fuller, Unique Challenges for Commercial Landlords Posed by Large-Scale Retailer Bankruptcies, Fuller explains the actions for which the landlord will need court approval:

  • Changing the locks on the premises or engaging in other self-help remedies.
  • Commencing or continuing to prosecute an action to evict the debtor.
  • Sending notices to the debtor to terminate the lease or revoke a right of lease renewal (even if the lease allows the landlord to take that action).
  • Demanding payment of past due rent.

Know the adage “easier to ask for forgiveness than permission?” Yeah, that doesn’t apply to this situation. If you fail to obtain court approval, prior to taking any of the above actions, you may be subject to fines, damages or even held in contempt of court, according to Fuller.

What about the Cash?

We recently discussed DIP financing, and Fuller recommends “Landlords should also review budgets because they often provide the first signal regarding the debtor’s intentions for the Chapter 11 case, including whether it will be maintaining or closing stores and on what timetable.”

And, while you are reviewing those budgets, check to see whether the budget allows for rent payments under administrative claims.

Accept or Reject?

Section 365 of the Bankruptcy Code is specific to the treatment of leases in a bankruptcy. Fuller provides four key issues for landlords regarding the treatment of their leases in bankruptcy:

  • Ensuring payment of post-petition rent and other lease charges, including stub rent.
  • The effect on the landlord of an assumption of the lease versus a rejection of the lease.
  • The circumstances under which the debtor can assign the lease, including the conditions particular to assigning shopping center leases.
  • Timing and other strategic considerations.

Ultimately, the bankrupt entity has an opportunity to review its leases and decide whether it is a lease they want to maintain (i.e. reject or accept). The debtor has up to 210 days to make decisions on their leases; decisions should be made within 120 days of the bankruptcy filing, but an extension may be granted for an additional 90 days.

Obviously, money is a driving factor for bankruptcy – if a debtor has some leases that are costlier or more restrictive than others, they will take this as a chance to reject or renegotiate those costly leases. A more favorable lease, such as one that is in a great location & likely seen as appealing to prospective buyers, will likely be assumed or accepted by the debtor. It should come as no surprise, landlords benefit from leases that are assumed or accepted versus those that are rejected.

Pro Advice

Fuller recommends landlords carefully review the bankrupt entity’s pleadings to “discern its intentions for its leases and then evaluate the benefit of joining forces with other landlords or pursuing rights individually.” My recommendation: Make sure you have legal representation! Don’t take on the challenge of legal documentation on your own.

DIP Financing: What Is It? Who Provides It?

Posted on August 17, 2018 by - Credit Risk Management, In Other Commercial Credit News

DIP Financing: What Is It? Who Provides It? What If You Filed a UCC?

DIP stands for Debtor in Possession. When a business files for chapter 11 bankruptcy protection, the existing management or ownership maintains possession and control of its business. However, the bankrupt entity needs financing to keep its business operational throughout the bankruptcy process. One way for a bankrupt entity to obtain cash is through DIP Financing.

Unfortunately, if a business is on the brink of bankruptcy, lenders aren’t usually eager to extend a loan to the business. To be fair, a lender’s hesitation to lend to a bankrupt entity is not unlike my hesitation to touch a hot stove – you know the risk and you know the consequences.

Given the risks of lending to bankrupt businesses, the Bankruptcy Code affords would-be lenders various perks, often including the benefit of a priority security interest.

In his article, DIP Financing: How Chapter 11’s Bankruptcy Loan Rules Can Be Used To Help A Business Access Liquidity, Bob Eisenbach mentions the perk of a priority security interest:

“When the debtor company has lined up a lender, it files a motion seeking Bankruptcy Court approval of the DIP financing. Typical DIP financing terms include a first priority security interest, a market or even premium interest rate, an approved budget, and other lender protections.”

The concept of priority over subsequent creditors may be referred to as a priming lien. Marshall S. Huebner, in Debtor-in-Possession Financing, further advises lenders may “insist on a first-priority priming lien on the debtor’s inventory, receivables, and cash (whether or not previously encumbered), a second lien on any other encumbered property, and a first-priority lien on all of the debtor’s unencumbered property.”

Who Provides DIP Financing?

Does this financing come from a random bank? Not necessarily. In fact, DIP financing often comes from prepetition lenders. According to Market Trends, Recent Deal Terms in Retail DIP Financing, author Jordan Myers refers to this as “defensive” financing.

“Prepetition lenders, rather than new third-party lenders, are a frequent source of DIP financing to retail debtors. They do so, in part, to protect their position against possible priming liens—a practice known as “defensive” DIP financing. “

What About Creditors with a Properly Perfected Security Interest: UCCs?

The American Bankruptcy Institute states a creditor with a properly perfected security interest has priority over DIP.

“…[I]f a secured creditor is perfected as of the petition date, its security interest trumps the DIP, and the estate benefits from the secured creditor’s collateral only after the secured creditor is repaid. However, if the secured creditor is not perfected as of the petition date, then the DIP prevails and the secured creditor shares pro rata with other unsecured creditors.”

Confused? ABI has a bubbly example!

“Consider this hypothetical: Donald the debtor owns a case of fine champagne. Your client, Cartman Corp., just won a lawsuit against Donald. You send out the sheriff to pick up the champagne to satisfy the claim. Under California law, once the sheriff lays his hands on the champagne, you’ve got a lien; other states may date the lien from the time you send your order to the sheriff, or perhaps even from the time you win your lawsuit. To recap: If some secured creditor is perfected before Cartman Corp. gets its lien, then that secured creditor gets first dibs in the champagne. Otherwise, first dibs go to the Cartman Corp.”

Takeaway? While DIP Financing holds significant benefits for the lender, a properly perfected security interest is certainly in a better position than an unsecured creditor. File UCCs!

Retail Bankruptcies and Their Impact on Consigned Goods

Posted on August 10, 2018 by - In Other Commercial Credit News, UCC Financing Statements

Retail Bankruptcies and Their Impact on Consigned Goods

The next time you take a trip to your favorite retailer, stop for a moment and think about the various goods for sale. Did the retailer order and pay up front for 100 pairs of tennis shoes, hoping it will sell every pair to recoup their costs + profit?

Not likely.

In most retail situations, the retailer obtains goods from various suppliers and the suppliers provide those goods on a consignment basis. Essentially, the supplier provides the goods to the retailer and the supplier maintains title to the goods until the retailer sells the goods. Once the retailer sells the goods, the supplier invoices the retailer for the cost of the goods sold. If the retailer doesn’t sell the goods, the retailer can simply return the goods to the supplier.

Although it’s not widely practiced, a supplier can and should ensure it takes appropriate action to perfect its security interest if supplying goods on consignment.

Article 9 & Consignment

Consignments hover somewhere between Articles 2 & 9 of the Uniform Commercial Code. We focus on what falls under Article 9. How do you know if the consignment falls under Article 9?

“UCC Section 9-102(a) (20), states the following:

Consignment means a transaction, regardless of its form, in which a person delivers goods to a merchant for the purpose of sale and:

(A) the merchant:

(i) deals in goods of that kind under a name other than the name of the person making delivery;

(ii) is not an auctioneer; and

(iii) is not generally known by its creditors to be substantially engaged in selling the goods of others;

(B) with respect to each delivery, the aggregate value of the goods is $1,000 or more at the time of delivery;

(C) the goods are not consumer goods immediately before delivery; and

(D) the transaction does not create a security interest that secures an obligation.”

Edwin E. Smith provides a great example in his article Understanding Consignments in Retail Bankruptcies.

“There are a number of consignment transactions that fall outside of the UCC definition. For example, I might take my bicycle to the consignment shop for sale by the shop. Since the bicycle is a consumer good in my hands before delivery, the consignment falls outside of the UCC definition. Or I may take my office desk chair used in my business to the consignment shop for sale. The office chair is not a consumer good in my hands since I use it in my business. However, if the chair’s value is less than $1,000, the consignment would fall outside of the UCC definition. The shop may use the term “consignment” in its name and may advertise on its website that it deals with consigned goods. In that case, a consignment to the shop may fall outside of the UCC definition since the consignee may be ‘generally known by its creditors to be substantially engaged in selling the goods of others.’”

Why File a UCC? One Word: Bankruptcy

When you sell on consignment and fail to perfect a security interest, you will join the pool of unsecured creditors if your customer files for bankruptcy protection.

“If the consignor does not file the financing statement, the consignee’s interest in the consigned goods is subordinate to a lien obtained by a creditor of the consignee using the judicial process.[23] Article 9 refers to that creditor as a “lien creditor.”[24] If the consignee became a debtor in a bankruptcy case, the consignee’s bankruptcy trustee under Section 544(a) of the Bankruptcy Code has the status of a hypothetical lien creditor. The trustee may use that status to set aside an unperfected consignment interest and treat the consignor’s claim to the goods as a general unsecured claim.”

Unsecured creditors may think they have a ‘fallback plan’ of reclamation or administrative claims under section 503(b)(9) of the bankruptcy code. But Smith reinforces that reclamation rights and administrative claims are only available to those who sold to the debtor. Technically, consignment is not a sale.

What can a creditor do if no security interest exists? Here are parting words from Smith:

“The consignor can take the position that the consignment falls outside of the UCC definition of the term “consignment,” usually because the consignee is “generally known by its creditors to be substantially engaged in selling the goods of others.” If the consignor is successful in that argument, the consignor, as owner of the goods, will, as mentioned above, prevail as to the goods over the claims and interests of creditors and the bankruptcy trustee of the consignee. However, that position depends on facts that may or may not favor the consignor and will lead to expensive and time-consuming litigation. A consignor’s understanding of the commercial law rules applicable to consignments, including those of the UCC, and careful planning by the consignor should avoid these types of disputes.”

Or – don’t risk it.

Always perfect a security interest. Always!