Search Results for: collateral description

UCC Collateral Descriptions – Don’t Be Too Specific or Too Vague

Posted on July 18, 2022 by - UCC Financing Statements

intellectual property illustration

Avoid Being Too Specific or Too Vague in UCC Descriptions of Collateral

The Case: IN RE PROVIDERX OF GRAPEVINE, LLC – BANKR. COURT, ND TEXAS, 2013.

A UCC Financing Statement must provide the name of the creditor, the name of the debtor and the description of property serving as collateral. The following case involved the description of collateral in a UCC-1 Financing Statement which expressly covered “patent applications.”

The court determined that this language did not cover other intellectual property (“IP”) of the debtor, which is unfortunate because intellectual property often constitutes a company’s most valuable asset.

In ProvideRX, CERx (“Creditor”) and PM (“Debtor”) entered into a number of loan agreements and security agreements related to a principal loan amount of $8.92 million.

One of the security agreements executed between the parties was a Patent Application Security Agreement that included a description of collateral in language nearly identical to that in the Creditor’s UCC filing.  However, the UCC filing did not contain the broader phrase “IP assets” that was contained in the loan documents.

What Did the Court Say?

Although the court acknowledged that the description of collateral must be more precise in a security agreement than a UCC Financing Statement, it still found the UCC collateral description inadequate to cover intellectual property other than patents.

The court noted that the description of collateral in a UCC filing only needs to put a prospective creditor on notice so that prospective creditors have reason to inquire further about existing security interests.

“…The primary issue remaining before this Court is whether the language in the loan and security documents entered into by and among the various parties was sufficient to grant CERx a security interest in all of PM’s intellectual property assets owned immediately prior to a December 13, 2012 foreclosure sale (collectively, the “IP Assets”). For the reasons detailed below, this Court concludes that (1) the loan documents are unambiguous and, as a matter of law, PM did grant CERx a security interest in all of its IP Assets; (2) although CERx’s security interest attached to PM’s IP Assets, the collateral description contained in the UCC-1 financing statement filed by CERx with the Texas Secretary of State was insufficient to perfect CERx’s security interest in PM’s IP Assets, other than the Patent Applications (defined on p. 17); (3) pursuant to its Notice of Disposition of Collateral, CERx only foreclosed upon PM’s Patent Applications; (4) thus, as of its bankruptcy petition date, PM held title to all of its IP Assets, other than the foreclosed-upon Patent Applications, subject to CERx’s unperfected security interest; and (5) because CERx failed to perfects its non-Patent Application security interests, such interests were unperfected when PM filed its bankruptcy case and are subject to avoidance pursuant to 11 U.S.C. § 544(a)(1)…”

The Decision

The court found that the language of the financing statement was insufficient and pointed out that the UCC Financing Statement specifically mentioned patent rights but failed to mention other forms of intellectual property like trademarks, source codes, copyrights and other IP related assets.

Because of this failure (to include a broad category like “IP asset” or to list specific types of IP assets), the court concluded that creditors reviewing the financing statement would assume that the debtor had not given a security interest in its IP assets beyond those related to patents.

The language describing collateral must be specific enough to put creditors on notice of the need to inquire further while being general enough not to omit property that is contemplated as collateral but not expressly enumerated.  A delicate balance indeed!

UCC Collateral Description: What You Should Include

Posted on March 16, 2020 by - UCC Financing Statements

What Should You Include in Your UCC Collateral Description?

A perfected security interest is nothing without a collateral description. 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 with collateral descriptions in both. In today’s post, we’ll review what to include in a UCC collateral description.

What Is a Sufficient Collateral Description According to Article 9?

First, what is collateral? Collateral can be either tangible or intangible. Some forms of tangible collateral are consumer goods, equipment, inventory and farm products. Some forms of intangible collateral are instruments which include any written evidence of the right to receive money, documents of title and receipts, chattel paper, accounts, general intangibles, healthcare receivables and supporting obligations.

Then, what makes a collateral description sufficient? 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.

Watch Out for these Common Collateral Mistakes

Collateral descriptions will vary based on the collateral used to secure the credit; however, there are key pieces of information that are sometimes overlooked or inadvertently omitted.

  • Don’t Forget the After-Acquired Collateral: phrases like “now owned or hereafter acquired” or “now existing and hereafter arising” are technically not required under Article 9, but experts agree it is smart to include the phrasing so as to not limit recovery.
  • Don’t Add Limiting Language: be careful when identifying collateral located at a specific address or acquired within a certain time frame. Adding limits to the language could do more harm than good. (Check out this post for an example of limitation by address.)
  • Say What You Mean, Mean What You Say: be aware of what may or may not be included in “all compassing” phrases such as “all proceeds thereof.” If you expect the security interest to include all accounts/accounts receivable, it’s best to include those terms in the collateral description.

Remember 1st Source Bank?

Remember the 1st Source Bank case? In this case, the key issue was whether the language describing specific heavy machinery and “all proceeds thereof” included the debtor’s accounts and accounts receivable.

1st Source Bank arranged for the lease or sale of certain equipment to K & K Trucking and J.E.A. Leasing (Debtors), which was subject to a security interest that was described in the UCC filing according to the above language. The terms “accounts” and “accounts receivable” were not included in the description of the collateral.

Subsequent to the 1st Source Bank UCC filing, the Debtors entered financing contracts with several other banks. These other banks, in turn, filed UCCs which specifically identified “all accounts receivable now outstanding or hereafter arising” as part of the collateral description.  When the debtor defaulted, these banks took control of the collateral, including the accounts receivable.  1st Source Bank objected based on its claimed priority security interest.

The issue before the court was whether the language referring to “all proceeds thereof” was sufficient to put future creditors on notice that 1st Source Bank held a security interest in “accounts” and “accounts receivable.”

The court determined “all proceeds thereof” did not include “accounts” and “accounts receivable.”

Why? Because “Although the statutory definition of the term ‘proceeds’ appears admittedly broad, accepting [1st Source Bank]’s interpretation of the statute would render the term ‘accounts’—a category defined separately in Chapter 9—meaningless. See Tenn. Code Ann. § 47-9-102(a)(2).”

Consequently, 1st Source Bank’s security interest was not perfected with respect to accounts and accounts receivable, providing the other banks a priority status even though their filings were recorded after 1st Source Bank.

Collateral is Key

Because the collateral that underlies a security interest is the key protection afforded to creditors in the case of debtor default or bankruptcy, collateral must be properly described in UCC filings. The description of collateral needs to put prospective creditors on notice so that prospective creditors have reason to inquire further about existing security interests. Be careful, there’s a fine line between being too specific and too generic.

When Your Collateral Description Sufficiently Complies with Article 9

Posted on May 17, 2019 by - In Other Commercial Credit News, UCC Financing Statements

Collateral Descriptions Are Tricky! It’s Hard to be Specific without Being Too Specific. Does Your UCC Sufficiently Comply with Article 9?

We know strict compliance with Article 9 is vital in perfecting your security interest. Collateral descriptions can be a tricky business; don’t be too specific or too vague. Fortunately for one creditor, a bankruptcy judge deemed its collateral description as “sufficient”, even though it included a specific address.

What Makes a Collateral Description Sufficient?

According to Article 9-108, a collateral description is “sufficient” if it reasonably identifies the collateral. Whether the collateral is identified by specific listing, category, quantity, or “computational or allocational formula,” it doesn’t have to be perfect, if it’s enough to put other creditors on notice.

“What? It doesn’t have to be perfect?”

Gosh, it’s tough when speaking in terms of perfection. So, I’m calling on author Francis Buckley, Jr. to help me out –

“Fortunately, the policy behind the law governing secured transactions under the UCC explains financing statements are meant to simply provide notice of the transaction and give enough information to subsequent potential creditors that the debtor’s property may be covered by a prior creditor’s security interest. Essentially, a financing statement is meant to provide a starting point in a subsequent creditor’s due diligence process, not the conclusion.”

Oooooh, I like that! “…a financing statement is meant to provide a starting point in a subsequent creditor’s due diligence process, not the conclusion.”

Yes, ideally your Financing Statement should be perfect. But mistakes do happen and while some mistakes are costly, others are forgiven, as is the case in the 8760 Service Group case.

In 8760 Service Group, the secured creditor added what Buckley referred to as an “address restricter,” essentially adding the address to its collateral description:

“All Accounts Receivable, Inventory, equipment and all business assets, located at 1803 W. Main Street, Sedalia, MO 65301.”

A subsequent creditor argued the inclusion of an address left the Financing Statement seriously misleading and the security interest unperfected. But Judge Dow disagreed with the subsequent creditor. According to Judge Dow the “UCC does not require a perfect collateral description… only an ‘indication’ of such coverage…”

Here’s an excerpt from Francis Buckley Jr.’s It May Be Foul, But There Is No Harm: Not All Mistakes Have Dire Consequences Under UCC Article 9:

“In an interesting twist, Judge Dow found that the existence of an ambiguity in the collateral description of the financing statement did not prejudice the prior-filed creditor, but instead provided sufficient notice to the subsequent-filed creditor to impose a duty of further inquiry into the nature of the secured transaction covered under the financing statement. Judge Dow pointed out that the court does not employ traditional means of statutory construction in analyzing an ambiguous financing statement because the court does not proceed to interpret the language. Instead, the court inquires whether the financing statement sufficiently describes the collateral such that ‘the subsequent creditor should have been on notice to inquire further into the collateral.’”

Best Practice? Take Your Time & Draft Carefully

Frequently I see collateral descriptions that tend to be a bit more general: “…in all payment intangibles, accounts, accounts receivable owed to ABC Company…” (Unless, of course, it is related to a specific piece of equipment where serial numbers come into play.)

My advice is be careful when drafting the collateral description. Understand that if you include an address, it may be deemed as seriously misleading. Not to mention the potential catastrophe: what if there is no collateral at that address?! If you do include an address, keep tabs on your customer – make sure they don’t move the collateral to another location.

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.”

UCC Filing Collateral Descriptions and Interpreting “And All”

Posted on July 9, 2018 by - UCC Financing Statements

UCC Filing Collateral Descriptions and Interpreting “And All” – With a Dab of Fixture Filings

The U.S. Bankruptcy Court in Missouri recently determined a creditor’s priority in collateral at one address and priority in a blast booth installed on another property, based on the creditor’s properly perfected security interest. Bonus? The Court also reviewed whether a blast booth meets the 3 parameters of a fixture.

Parties Involved & a Bit of Background

To make it a bit easier to understand a somewhat confusing case, here’s a breakdown of the parties involved:

  • Primary Lender: Bancorpsouth Banc (BB)
  • Debtor 1: 8760 Service Group, LLC (8760), sole managing member is Buck Barnes
  • Debtor 2: Pelham Property, LLC (Pelham), sole managing member is 8760
  • Surety issued performance & payment bonds to 8760: Hudson Insurance Company (Hudson)
  • Bankruptcy Trustee (Trustee)

BB was the primary lender for debtors 8760 and Pelham. According to the Court, Pelham was the obligor on the loan from BB, and 8760 was the guarantor. In consideration for the loan, debtors granted BB a security interest in inventory, equipment and A/R. BB filed a UCC to perfect its security interest. The initial UCC was filed in 2014, and a subsequent amendment was filed in 2015.

Hudson issued a performance & payment bond for 8760, and as collateral for the bonds, 8760 granted a security interest in its inventory, equipment and A/R. Hudson filed a UCC to perfect its security interest in 2017.

Both creditors, BB in 2015 & Hudson in 2017, were granted a security interest in the debtor’s inventory, equipment and A/R. So, who has priority? Based simply on “first in time, first in right,” BB would have priority. However, if BB’s collateral description makes its UCC seriously misleading, Hudson jumps to the front of the line.

BB’s Collateral Description, too Vague?

The primary issue was whether BB’s collateral description was sufficient, or if its UCC was seriously misleading. Hudson, 8760 and Pelham argued that because BB’s collateral description included a street address, it was restricted to only collateral located at that address.

Collateral Description from 2015 UCC:

“All Accounts Receivable, Inventory, equipment and all business assets, located at 1803 W. Main Street, Sedalia, MO 65301.”

and included an additional page with:

“the above collateral, whether now owned or hereafter acquired, together with all supporting obligations, proceeds, products, software, accessories and accessions, including, but not limited to the items listed…”

 As you can see, the collateral description includes a street address. What you may not see, and I admittedly did not see initially, is the collateral description can be interpreted one of two ways, depending on how you understand the words “and” and “all.”

Hudson argued the collateral description was limited to A/R, inventory, equipment and business assets ONLY located at 1803 W. Main Street.

Whereas, BB argued the collateral description included ALL accounts receivable, inventory, equipment AND ALL business assets located 1803 W. Main Street.

Fortunately for BB, the court was persuaded by its argument. BB’s collateral description should have prompted Hudson to further investigate, when Hudson went to file its UCC 2 years after BB.

“The ‘and’ in the collateral description between ‘[a]ll Accounts Receivable, Inventory, equipment’ and ‘all business assets, located at 1803 W. Main Street, Sedalia, MO 65301’ could at least have given Hudson an indication that all assets were covered by a prior lien and cause it to inquire into the collateral description contained in the security agreement.”

The result? BB has priority.

“Thus, [BB’s] collateral description in the financing statement was not seriously misleading and was sufficient to put Hudson on notice that it should inquire into the extent of [BB’s] lien. Because [BB] indisputably filed prior to Hudson, it holds a first priority security interest in 8760’s non-office equipment and inventory.”

Blast Booth Bonus: is it a Fixture?

8760/Pelham’s assets included a blast booth. Hudson argued the booth should be considered equipment and not a fixture. While the argument is moot because BB has already been granted priority in all assets, the court did review whether the booth is equipment or fixture.

In its opinion, the court cites the 3 requirements, set forth by Missouri Supreme Court, an item must meet to be deemed a fixture: annexation, adaption, and intent of the annexor.

The court advised an item is annexed if it is, in some way, physically attached to the real property. Adaptation exists, if the building was designed specifically to accommodate the item or if the “alleged fixture was necessary for the particular use to which the premises are devoted.” And lastly, intent of the annexor, is whether the intention existed for the item to become an integral part of the real property.

“[T]he Blast Booth was bolted into the concrete floor of the 5105 Pelham Drive building and the building was specifically designed to incorporate the Blast Booth by installing special trenches for augers in the concrete floor. He testified that if the Blast Booth was removed the trenches would have to be covered or filled with concrete and the bolts would have to be cut off flush with the floor and driven down into the concrete floor to repair the area where the Blast Booth was located. Further, he testified that when Debtors installed the Blast Booth in the building he did not intend for the Blast Booth to ever be removed.”

Therefore, the blast booth met the parameters: it was affixed to the property, the building was built to accommodate it, there was no intention for it to be removed.

Blasting Booth = Fixture

Note: This case was rather interesting, and it wasn’t limited to the items discussed above. You can read the full text here: IN RE 8760 SERVICE GROUP, LLC, Bankr. Court, WD Missouri 2018

Creditor’s OMEGA Mistake Started with Collateral Description

Posted on August 24, 2015 by - UCC Financing Statements

closed lap top computer with eyeglasses on top

Creditor’s OMEGA Mistake Started with the Collateral Description in Its UCC Filing

In Omega Optical, Inc. 476 B.R. 157 (Bankr. E.D.Pa. 2012) (“Omega”) Omega filed bankruptcy and listed Sovereign Bank (“Sovereign”) as a secured creditor within the filing. Indeed, Sovereign was a secured party, as they had filed a UCC Financing Statement. Unfortunately for Sovereign, they made a few mistakes… a few costly mistakes.

Oh the Collateral Description

In the filing, Sovereign described the collateral as “all assets.” As you know, a vague collateral description can be fatal. Article 9 does allow a creditor to list collateral as “all assets” on the actual financing statement, but the creditor must provide a more thorough collateral description within the Security Agreement.

In this case, however, the Bankruptcy Judge, Bruce Fox, deemed the collateral description of “all assets” as it appeared on the financing statement to be:

“…super-generic and not sufficient to effectively perfect a lien on any collateral. In addition, the description of the collateral is limited to the collateral that existing [sic] at the time the lien was filed, and does not extend to any collateral acquired after the lien was filed. Therefore, Sovereign Bank’s lien is not properly perfected.”

Reclassified aka Demoted

Because the UCC was not properly perfected, Omega’s proposed reorganization plan demoted Sovereign’s claim to that of an unsecured creditor. Once demoted to unsecured, Sovereign’s UCC was terminated and all security (or potential security) forfeited. The court subsequently held a plan confirmation hearing and Sovereign did not object to the plan – the very plan which indicated they were unsecured. They, Sovereign, even filed an unsecured proof of claim.

Did Sovereign not realize it had been bumped from secured to unsecured? Why wouldn’t they object to a plan that could cost them a significant amount of money?

Yes, Sovereign “knew” it had been bumped, meaning, Sovereign did not object to the plan, which for all intents and purposes indicates that they knew they were considered unsecured.

“I object” came, but it came too late.

A few months after the plan confirmation, Sovereign filed a motion requesting to amend their proof of claim, stating that their lack of objection to the plan and that asserting an unsecured proof of claim was an “obvious oversight.”

As an aside, Section 506(d)(2) of the Bankruptcy Code does state that failing to provide a proof of claim does not, by itself, void the lien:

“Sections 501 and 1111 of the Code govern the filing of proofs of claims. In a Chapter 11 proceeding, only creditors whose claims are listed by the debtor as “disputed, contingent, or unliquidated” are required to file proofs of claim. Bankruptcy Rule 3003(c)(2) directs that a creditor so listed must file, and that one who fails to do so will not be treated as a creditor “with respect to such claim for the purposes of voting and distribution.” This rule does not, however, extinguish a creditor’s lien as a penalty for failure to file a proof of claim. In fact, the legislative history of § 501(a) indicates that it is “permissive only, and that no creditor is required to file a proof of claim.”… However, “the filing of a proof of claim is a prerequisite to the allowance of unsecured claims, including the unsecured portion of a secured claim, and priority claims.” Furthermore, “[f]iling a proof of claim may be unnecessary… in situations in which the creditor is secured and has not asserted a claim against the estate, and no determination under section 506(d) has been requested.”

So, if Sovereign’s only error was thatthey “forgot” to file a proof of claim or “accidentally” filed the wrong proof of claim, their lien likely would not have been vacated. But, because Sovereign’s UCC was deemed unperfected AND they neglected to file the proper proof of claim, 506(d)(2) can’t “save” them.

Four Parts

According to the bankruptcy judge, when determining whether or not a lien is extinguished by the confirmation process, there is a “four part test”:

“Four conditions must therefore be met for a lien to be voided under section 1141(c): (1) the plan must be confirmed; (2) the property that is subject to the lien must be dealt with by the plan; (3) the lien holder must participate in the reorganization; and (4) the plan must not preserve the lien.”

Unfortunately for Sovereign, they got 4 out of 4 on this test:

  • The plan was confirmed
  • The property (collateral) was dealt with by the plan
  • Sovereign participated when they submitted the unsecured proof of claim
  • The plan considered Sovereign unsecured, which means the lien was not preserved

Lessons Learned

  • Properly identify the collateral in the UCC filing (quite frankly, much of this could have been avoided, if the collateral description was sufficient enough to keep the UCC in play).
  • File the proper forms & pay attention (nothing worse than being the only kid who didn’t do their homework and getting called out on it later).

Collateral Description in UCC Filings: a Case from Tennessee

Posted on June 17, 2014 by - UCC Financing Statements

Collateral Description in UCC Filings: a Case from Tennessee

A recent case decided by the Sixth Circuit Court of Appeals, 1st Source Bank v. Wilson Bank and Trust et al., 2013 WL 5942056 (No. 13-5088), provides an example of the importance of properly describing collateral in a UCC filing to perfect a security interest. In the case, the key issue was whether or not the language describing specific heavy machinery and “all proceeds thereof” was sufficient to include the debtor’s accounts and accounts receivable.

What Was Included in the Collateral Description?

In 2004, 1st Source Bank arranged for the lease or sale of certain equipment to K & K Trucking and J.E.A. Leasing (Debtors), which was subject to a security interest that was described in the UCC filing according to the above language.

The terms “accounts” and “accounts receivable” were not included in the description of the collateral. Subsequent to the 1st Source Bank UCC filing, the Debtors entered into financing contracts with a number of other banks.

These other banks, in turn, filed UCCs which specifically included “all accounts receivable now outstanding or hereafter arising” as part of the collateral description.

When the debtor defaulted on the financing arrangements, these banks took control of the collateral, including the accounts receivable.  1st Source Bank objected based on its claimed priority security interest.

What Did the Court Say?

The issue before the court was whether the language referring to “all proceeds thereof” was sufficient to put future creditors on notice that 1st Source Bank held a security interest in “accounts” and/or “accounts receivable.”

Generally, the legal standard for description of collateral in a UCC filing is that it “reasonably identify what is described.”  Courts have interpreted this as meaning that it must be sufficient to create a reason to inquire further about the existence of a security interest in the collateral.

The court addressed the argument that “all proceeds thereof” in the UCC was sufficient to encompass “accounts” and “accounts receivable.” The court noted that Chapter 9 of the Tennessee Uniform Commercial Code (UCC) defines “accounts” separately.

The court determined that the term “proceeds” must refer to something different or the use of the term “accounts” would become superfluous.  The court also relied on the commentary to Article 9 that indicated the term “proceeds” was not to be construed particularly broadly, so it did not make sense to have it include all monies generated by the equipment.

Consequently, 1st Source Bank’s security interest was not perfected with respect to accounts and accounts receivable, providing the other banks a priority status even though their filings were recorded after 1st Source Bank.

Getting It “Just Right” Can Be a Challenge

Because the collateral that underlies a security interest is the key protection afforded to creditors in the case of debtor default or bankruptcy, collateral must be properly described in UCC filings.  The description must be sufficient, to provide notice to prospective creditors of the property encumbered by a prior security interest.

On the other hand, the description should not be so specific and narrow that key forms of collateral are not encompassed within the description in the UCC Financing Statement.  A creditor with a senior security interest can forfeit a priority position when the UCC collateral description is defective.