Service Area: Collection Services

Bankruptcy Payout Priority – Secured Creditors Make Bank

Posted on December 23, 2014 by - Credit Risk Management

Bankruptcy Payout Priority – Secured Creditors Make Bank

As a credit professional, you’ve likely heard this once or twice: “It’s better to be a secured creditor than an unsecured creditor.” After all, credit is how the majority of us do business in today’s economy and, as credit professionals, we want to insure we are paid for the goods & services we provide.

I often hear secured-credit-skeptics say “If my customer files bankruptcy, I won’t see a dime, why waste my money on a UCC or lien” or “Once the courts get paid, there won’t be anything left for me” and, my favorite, “My customer and I have a great relationship, they’ll never fail & I will always get paid.”

“If I file a UCC Financing Statement is it a guarantee that I will get paid?”

As with everything in life, there are no guarantees – with the exception of death and taxes. No, you are not guaranteed to be paid in the event your customer files bankruptcy; however a perfected UCC filing will make you a secured creditor, which would put you in the best possible position to get paid.

“If a company files bankruptcy, which creditors get paid first?”

The bankruptcy code is specific, detailed and, well…it’s long – but here is the basic payout priority:
Payout Priority in Chapter 11 Bankruptcy

  1. Secured Creditors (i.e. creditors who have a perfected security interest)
  2. Administrative Expenses (i.e. costs associated with filing & processing the bankruptcy)
  3. Unsecured Creditors (i.e. creditors without a security interest)

“Do creditors really get paid?”

Yes, creditors really do get paid – although every bankruptcy exit plan is different. Let’s take a look at a few bankruptcy cases, which demonstrate the immense benefit of being a secured creditor rather than an unsecured creditor.

  • Filene’s Basement “Secured creditors have been paid in full, holders of priority claims and convenience class claims have received 100% of their allowed claims, and unsecured creditors have been paid 50% of their allowed claims.”
  • Uno “The plan gives the holders of $142 million of senior secured debt 100 percent of the stock in the new company. Unsecured creditors who sell their claims will receive about 13 percent.”
  • HomeBanc Corp.  “The accompanying disclosure statement says that unsecured creditors with $223.5 million in claims would recover between 1 percent and 10 percent. Secured creditors with claims of $69.6 million would be paid fully.”
  • Intermet Corp. “The disclosure statement says first-lien creditors should expect a 70 percent recovery while second-lien term loan lenders, owed $107 million, and unsecured creditors with $93 million in claims, could realize around 1 percent.”

Although there are no guarantees, time and time again we see secured creditors receiving more funds than unsecured creditors.

The information presented here illustrates that secured creditors are in the best possible position to get paid. However, this assessment does not guarantee a payout in future bankruptcies.

What is Subordination?

Posted on December 16, 2014 by - UCC Financing Statements

Avoiding Potential Pitfalls When Entering into a Subordination Agreement

What is Subordination?

Subordination is “the process by which a creditor holding a priority debt agrees to accept a lower priority for the collection of its debt in a deference to a new debt.” according to Cornell University Law School’s Legal Information Institute. Or “A written contract in which a lender who has secured a loan by a mortgage or deed of trust agrees with the property owner to subordinate its loan (accept a lower priority for the collection of its debt), thus giving the new loan priority in any foreclosure or payoff.”

There are instances when a secured creditor decides to subordinate a senior-priority position to another creditor because it increases the prospects of the obligation being satisfied.

However, if a creditor is considering whether or not to provide financing, equipment or other assets based on obtaining a senior priority position, by swapping priority with an existing creditor, said creditor must be cautious of this approach.

The junior-priority creditor entering into the subordination agreement must carefully review the security agreement and perfection procedures undertaken by the pre-existing creditor to determine that the prior security interest was properly perfected.

Pitfalls of Subordination

The recent case of Caterpillar Financial Services v. Peoples National Bank, N.A. (March 4, 2013) from the Seventh Circuit of the U.S. Court of Appeals, reveals the potential pitfall of entering into a subordination agreement without an experienced professional lien processing service.

In Caterpillar, the debtor obtained loans to purchase mining equipment from three separate entities: (1) Peabody Energy Corporation (“Peabody”), (2) Caterpillar Financial Services Corporation (“Caterpillar”) and (3) Peoples National Bank (“Peoples”).

Each of the creditors extended their loans in the order indicated and filed their UCC Financing Statement at the time of obtaining the loan so they had the priority position indicated above. Debtor eventually defaulted on all three loans.

Partial Subordination or Total Subordination?

When Peoples obtained its loan, Peabody agreed to subordinate its first position, in terms of priority, to Peoples to increase the possibility that Debtor would have the ability to repay the Peabody loan.  The court addressed whether the subordination agreement permitted Peoples to move ahead of Caterpillar in terms of priority.  The court observed that there are two approaches to subordination – “partial subordination,” which constitutes the majority approach and “total subordination,” which is followed in a minority of jurisdictions.

“The “partial” in “partial subordination” denotes the fact that the parties to a subordination agreement swap places in the priority ladder only to the extent of the smaller of the swapping parties’ loans. If, for example, Peabody had been owed $1 million by S Coal, the subordination agreement would have given the bank [Peoples] first priority only with respect to the first $1 million of the bank’s $1.8 million loan. The order of priority would then be bank ($1 million), Caterpillar ($7 million), bank ($.8 million), Peabody ($1 million). The amount subordinated is limited to the amount that the creditor having priority over the nonparty was owed before he swapped places with a junior creditor. In the real as distinct from the hypothetical case, S Coal owed Peabody at least $4 million, which was much more than the bank’s loan, and so the bank was able to move into first place for its entire loan without hurting Caterpillar.”

The partial subordination approach allows the creditors to actually swap positions, so that the junior secured creditor Peoples would actually jump ahead of Caterpillar.  By contrast, the total subordination approach would have had Peabody simply take the position of Peoples without Peoples jumping ahead of Caterpillar.

While the Seventh Circuit observed that it followed the partial subordination approach, this was not the end of the analysis. Peabody was unable to produce a security agreement authenticated by the debtor that identified the collateral.

Because the first position priority interest of Peabody was not properly perfected, the subordination agreement did not permit Peoples to assert a security interest with a more senior-priority than Caterpillar.  Further, the court noted that even if Peabody’s security interest had been properly perfected, Peoples could only claim priority status in relation to Caterpillar up to the amount of the Peabody loan.

This would seem a fair resolution because it prevents Caterpillar from being prejudiced by the subordination agreement to which it was not a party.  The priority of Caterpillar would remain unchanged with the same amount of secured indebtedness needing to be paid prior to Caterpillar having its debt satisfied.

This case demonstrates that, under the majority approach, subordination agreements can be an effective tool for prospective creditors requiring additional collateral.  Since the senior creditor may be facing the prospect of not being paid if the debtor is financially struggling, the senior creditor may be agreeable to a lien subordination agreement.

However, prospective creditors considering such an approach need to carefully review the security agreements and UCC filings of the other party to the subordination agreement.

Debtor Name Errors in UCC Filings

Posted on November 12, 2014 by - UCC Financing Statements

The Impact of Debtor Name Errors in UCC Financing Statements

Perfection of a security interest involves drafting and executing a sound security agreement, properly filing a UCC Financing Statement and ensuring the filing complies with Article 9 of the Uniform Commercial Code.  When preparing a UCC filing, minor deviations in the name of the debtor can prevent a security interest from being perfected.  Creditors may assume it is enough to simply conduct an online search to determine the correct spelling of a debtor’s legal name. However Article 9-503 (a) states that for a registered entity one must obtain the organic public record.  Minor discrepancies coupled with strict state search logic can add up to a costly mistake.

Unperfected Security Interest

Let’s take a look at a few cases where the creditor failed to perfect their security interest, because searches conducted using the jurisdiction’s search logic did not reveal their UCC filing.

Jurisdiction: Nebraska
Case: EDM Corporation, doing business as EDM Equipment, doing business as NOVI, LLC, Debtor
Hastings State Bank, Plaintiff-Appellant v. Thomas D. Stalnaker, Chapter 7 Trustee of EDM Corporation
Verdict: The Court of Appeals for the Eighth Circuit affirmed the bankruptcy court’s ruling that the bank’s financing statement was “insufficient due to the addition of d/b/a” as part of the debtor’s name.

The bank listed the debtor’s name on the UCC filing with both the debtor’s public record and the d/b/a names.  The debtor’s name was EDM Corporation and its d/b/a was EDM Equipment.  The bank used a non-standard-form financing statement and listed the debtor as “EDM Corporation d/b/a EDM Equipment.”  Subsequently, two separate lenders failed to turn up the financing statement when conducting UCC searches.  The court noted that the standard-form financing statement expressly indicated not to include a d/b/a or other extraneous information in the field for the debtor’s name.  The court emphasized the importance of putting in the exact public record name of the debtor – no more and no less.

Jurisdiction:  Idaho
Case: Wing Foods, Inc., Debtor. Bankruptcy Estate of Wing Foods, Inc., by and through its Chapter 7 Trustee, Gary L. Rainsdon Plaintiff, vs. CCF Leasing Company and B S & R Equipment Company, Defendants.
Verdict:  The court determined the UCC Financing Statement was “fatally flawed” and as a result, the debtor was permitted to avoid the creditor’s security interest.

The creditor, CCF Leasing Company, leased equipment to Wing Foods, Inc. The creditor took steps to perfect a security interest by filing the UCC; unfortunately, the financing statement listed the debtor’s name as “Wing Fine Food.” The court found that the difference in the name was seriously misleading because a UCC search, using the jurisdiction’s search logic, would not have revealed the financing statement.  Because the filing was seriously misleading, the court ruled that Wing Foods, Inc. was able to avoid CCF Leasing Company’s security interest in its Chapter 7 bankruptcy.

Jurisdiction: Texas
Case: In re JIM ROSS TIRES, INC.; dba HTC Tire Pro; dba HTC Tires & Automotive Centers, Debtor(s).
Verdict: The court found the listing of the debtor’s name “seriously misleading” because the search logic used for UCC searches in the state would not have revealed the financing statement.

On the UCC Financing Statement, the creditor listed the debtor by including both the debtor’s legal name and d/b/a – “Jim Ross Tires Inc. DBA HTC Tires and Automotive.” The creditor argued their security interest was perfected, because their filing could be located using a “non-standard wild card search”; unfortunately for the creditor, the court did not agree with their argument.  “Accordingly, the Court finds that the Financing Statements are ineffective to grant security interests in Debtor’s collateral. Although this result is harsh, the Court must examine the result in the context of claims between competing creditors.”

Jurisdiction: Georgia
Case: Receivables Purchasing Co., Inc. v. R&R Directional Drilling, L.L.C.
Verdict: The appeals court affirmed the trial court, which determined the creditor did not have a security interest, because the financing statement was seriously misleading.

The creditor in this case simply added a space in the name of the debtor listing it as “Net work Solutions, Inc.” The creditor requested the Georgia Superior Court Clerks Cooperative Authority (GSCCCA) perform a search: “The GSCCCA did a certified search under the correct name Network Solutions, Inc. The Search did not reveal (debtor’s) financing statement, which…was filed incorrectly under Net work Solutions, Inc.”

Avoid this UCC Filing Mistake

While some creditors attempt to search online for a debtor’s business name, minor alterations to the name or the inclusion of a d/b/a could be fatal to the filing.  We recommend you obtain the debtor’s corporate legal name from the Articles of Incorporation filed with the state and monitoring the entity’s name for any subsequent changes. In addition to confirming your debtor’s corporate legal name, it is important understand the search logic used in the state because including a space where one does not belong or changing “and” to “&” in the debtor’s name may be enough to render a UCC filing ineffective.

Past Due Accounts and Commercial Collections

Posted on October 7, 2014 by - Credit Risk Management

Collections, Collections, Collections

It doesn’t matter how it’s said or how often it’s said, the word “collections” often elicits a negative reaction. In fact, a cringe followed by an eye roll and loud sigh is one of the most common reactions. This cringe-eye-roll-sigh we experience is typically due to an unfortunate & frustrating experience…

“I have hired collection agencies in the past. They were difficult to deal with, the fees were out of control and our money was rarely recovered.”

What can you do to make the collections process less painful for your credit teams? Why is it important to partner with the right agency? What can you do to reduce the need for collection services altogether?

Before we tackle these questions, let’s define the 3 common steps that lead to a need for collection services:

  1. Extend credit to your customer
  2. Your customer doesn’t pay within agreed upon billing terms
  3. You spend the next few months frustrated over endless phone calls and broken promises

Yes, this is an oversimplification and you don’t need me to tell you the steps, because we (you and I) know you have encountered this time and time again.

What Can You Do to Make the Collection Process Less Painful?

If you find yourself staring at your phone, loathing the idea of calling on past due accounts, make sure you have everything about your customer at the ready, before making the call. Review the history of the account, have copies of open invoices available. Make sure you know whether or not this is typically a slow-paying customer, have they made payment arrangements and failed to keep the arrangements, have you limited their credit because of their inability to pay timely.

It’s also important to not wait until the 11th hour to start contacting your customer, the longer an account remains unpaid, the harder it is to collect. I recommend you make a collection schedule and more importantly, stick to it.

Here is an example of a schedule:

30 Days Past Due

Call your customer and simply ask when you can expect payment for the open invoice

Asking a simple question like “Could you please tell me when invoice #4619661 will be paid?” is likely to be perceived as a “check-in” call and your customer may provide insight as to why the invoice is past due.

Based on the information your customer provides, you may find the invoice “got lost” or you may find you will need to be more straightforward.

*DON’T let your customer off the phone without getting a firm pay date; setting an expectation and then following through to ensure that expectation is met makes your customer accountable, but it also makes you accountable, which limits the number of accounts that slip through your fingers.

45 Days Past Due

Call your customer, if verbal negotiations are a struggle, send a demand letter

Demand letters can do wonders in prompting payment. Make sure your demand is clear: include the dollar amount outstanding, the date you expect payment and what the consequences will be if payment is not received. (i.e. “If we do not receive the payment within 10 days of receipt of this letter, we will have no choice but to proceed with the next legal action…”)

60 Days Past Due

Call your customer with a final warning; place account with a collections agency

Once the date set forth in the demand letter has come and gone, it’s time to provide one last opportunity to your customer and then place the account with an agency – after all, you have more than one customer to keep tabs on.

The longer an account is held, the less likely it is that it will be recovered. If payment or a payout is not arranged within 90 days, place the claim with a collection agency.

 Why It’s Important to Partner with the Right Collection Agency

Selecting a collection agency is not usually a pleasant or easy process. But, when extending credit, it’s a necessity. When it is time to outsource to a collection agency, make a list of the qualities you would like the agency to have.

For example, some companies are interested in collection agencies that are more persistent, aggressive and forceful, while other companies prefer agencies that adopt a straightforward, professional business-like attitude, with willingness to negotiate.  Or, you may wish to choose an agency that will tailor their approach to your circumstances.

It’s also important to ask about the fee structure and have a clear understanding of the steps the agency will take on your behalf.

What You Can Do to Reduce the Need for Collection Services

The answer to this question is easy: secure your receivables! Utilize the UCC process or the Mechanic’s Lien process to ensure you are a secured creditor. As a secured creditor you have leverage, backed by law, which often makes getting paid easier.

The Art of Drafting a Perfect Security Agreement for Your UCC Filing

Posted on September 24, 2014 by - UCC Financing Statements

There’s an Art in Drafting a Perfect Security Agreement for Your UCC Filing

Today we take a field trip to the Museum of Art and examine “Starry Night” by Vincent van Gogh. At first glance, “Starry Night” may look like a child swirled a paint brush around, hastily drew a few houses with a black magic marker, and added a church steeple, with some lazy-cartoon-like mountains in the background. But, as we know, a child did not create this piece of art; an artist created this piece – someone who honed his craft to absolute perfection. Every swirl in this painting is deliberate, precise in size and tone – all of its contents make it a single masterpiece.

OK, but what does “Starry Night” have to do with a Security Agreement and the UCC filing process? Often, Security Agreements and artistic masterpieces are incomplete. And while an incomplete piece of art may be on display, with no one judging it as “incomplete,” a security agreement does not have the same privilege.

Perfection, Precision, Masterpiece

Drafting a solid Security Agreement (perhaps not as aesthetically pleasing as “Starry Night”) is also an art form. Designed to mitigate risk and to grant creditors security in the event of debtor default, meticulous details combine to create a perfected security interest, i.e. the UCC-1 Financing Statement.

The most common errors in Security Agreements are often as simple as omitted details. Perhaps it’s a misspelled debtor name, the absence of a granting clause or a vague collateral description. So, what makes a solid Security Agreement?

Correctly Identify the Debtor.

There are oodles of cases demonstrating the devastating consequences of incorrectly spelling the debtor’s name in a Security Agreement or UCC Financing Statement.

Include the Debtor’s Address.

Not only should the debtor’s address be included, but it’s also imperative the address be correct.

Date the Agreement.

Confirm the document is dated – this is a great rule of thumb when your debtor signs any document for you.

Ensure the Signors are Authorized.

It is unfortunate to discover the individual who signed the document does not have the authority to sign, or all partners/members do not sign.

Include the Granting Clause.

A Security Agreement is nothing when the granting clause is missing, after all, it actually grants the security interest.

Clearly Identify Collateral.

This is a touchy subject. Often, collateral descriptions are too vague or too specific. Creating the right balance to ensure you have effectively covered the collateral is tricky.

Reference Governing Law.

Don’t forget to include reference to the governing law.

NCS Can Help

Properly perfecting a security interest through Article 9 of the Uniform Commercial Code is an art form. Make sure all of the required information is included and accurate. If in doubt, seek assistance from a professional.

Your Customer Defaults, Fortunately You Filed a UCC – Now What?

Posted on September 3, 2014 by - UCC Financing Statements

Your Customer Defaults, You Filed a UCC – Now What?

Congratulations, you filed a UCC to position yourself as a secured creditor! Unfortunately, your customer has defaulted on payments. You have attempted to work with your customer regarding their past due account, but they are still unable to meet the commitment – now what?

Any time your customer has defaulted on payments, we recommended you take immediate action to recover the funds; the longer an account remains unpaid, the harder it becomes to collect. A great, and relatively inexpensive, first step is to send a Demand Letter. A demand letter is a demand served upon your debtor, advising legal action may be taken if payment is not received within a specified time frame.

In the event the demand letter does not prompt payment, you may need to proceed with further legal action. Your next course of action is dictated by the type of UCC you filed.

Did you file a PMSI UCC?

If your customer has defaulted on payment(s) and you have filed a Purchase-Money-Security-Interest (PMSI) UCC, you need to determine whether or not you would like your equipment/inventory (aka goods) back.

  • If you do not want your goods back, you can place your claim with an attorney to file suit. By filing suit, you may receive Judgment, which allows you to garnish accounts and/or attach to assets.
  • If you do want your goods back, and your customer has the goods, you have the right to repossess without disturbing the peace.

If you are unable to peacefully repossess the inventory/equipment, you could take legal action by filing a temporary restraining order or by filing suit against your debtor.

Did you file a Blanket UCC?

If your customer has defaulted on payment(s) and you have filed a Blanket UCC, you could place the outstanding debt with a collection agency or file suit against your debtor.

Has your customer filed bankruptcy?

Keep in mind, the bankruptcy court freezes all debtor assets.

  • If your customer filed Chapter 7: File your secured proof of claim, regardless of whether you filed a PMSI or Blanket UCC.
  • If your customer filed Chapter 11:
    • PMSI UCC:  If you would like your goods back and your goods are at your customer’s location, contact the Trustee to repossess. If the Trustee is uncooperative, you may need to take additional legal action.
    • Blanket Filing: File a secured proof of claim and monitor for distribution.

Of course, as in any situation, it is in your best interest to seek legal advice and it is important to remember, a UCC filing is a remedy and not a cause of action in suit.

Articles of Incorporation: Not Just for Name Verification

Posted on July 15, 2014 by - UCC Financing Statements

Articles of Incorporation: Not Just for Name Verification

Do you know that if your customer changes their name you must amend your UCC filing or your security is jeopardized? Did you know Articles of Incorporation are required to verify an entity’s legal name and to verify jurisdiction?

Per Section 9-507(c) of the UCC, the secured party has four months to amend a UCC filing when the debtor’s name changes. If the secured party does not amend the UCC filing, the filing is not effective to perfect a security interest in collateral acquired by the debtor before or within four months after the change.

Best Practice

Make sure your Security Agreement requires your debtor advise you of any changes to their name, address or organizational structure. It is your responsibility, as the secured party, to ensure the UCC filing is updated and contains the correct information.

You can also utilize resources like our Corporate Monitoring, which will alert you when the State Corporation Division reports a change in your customer’s corporate profile along with decision making information to keep the UCC Financing Statement in compliance with Article 9-507(c).

Articles of Incorporation are not only required under UCC Article 9 to verify the entity legal name, but must also be used to verify jurisdiction.

In this example, the state of Texas is reporting the entity as a Foreign Limited Partnership organized in Delaware. However, if you review the Articles, you will discover the LP is actually organized in California. If the documentation had not been reviewed, the UCC would have been filed in the wrong jurisdiction, consequently there would be no security interest.

Secured Transaction Takeaway: Always review all documents carefully!

What a Difference a Name Makes: Omission of “Inc.” Left Security Interest Unperfected

Posted on June 30, 2014 by - UCC Financing Statements

What a Difference a Name Makes: Omission of “Inc.” Left Security Interest Unperfected

The proper spelling of a debtor’s name on UCC Financing Statement is currently one of the most fervently litigated UCC issues. The UCC Article 9 registry system is designed to permit creditors to make a security agreement public by filing a UCC Financing Statement. UCCs are indexed by the name of the debtor to facilitate the ability of creditors to search and identify pre-existing security interests.

Even Minor Spelling Differences Matter

Even minor spelling differences in a debtor’s name can result in a creditor’s security interest being unperfected.  The case of Tyringham Holdings, Inc. vs Suna Bros Inc., heard in the United States Bankruptcy Court for the Eastern District of Virginia, demonstrates the impact of something as simple as omitting “Inc.” from the debtor’s name in a UCC filing.

Tyringham Holdings, Inc. (Tyringham) entered into a consignment agreement to hold items of jewelry for Suna Bros. Inc. (Suna). Suna filed a UCC to perfect a security interest in the jewelry in the amount of $310,925.

The financing statement filed by Suna listed the debtor’s name as “Tyringham Holdings.”  The debtor’s actual name, per the corporate certificate was “Tyringham Holdings, Inc.”  Evidence submitted in the case revealed that a UCC search, certified by the State Corporation Commission for Virginia, did not yield the UCC Financing Statement under the name “Tyringham Holdings.”

The court noted the name of a corporate debtor that is listed on a UCC must match the name of the corporation on the public record of the jurisdiction where it was organized. However, the court also conceded that minor errors and omissions in the name do not necessarily mean that a security interest is unperfected.

Substantial compliance with the requirements of a UCC Financing Statement can be sufficient, provided that the name of the debtor in the UCC is not “seriously misleading.”  The court cited similar cases in other jurisdictions that found a debtor’s name is seriously misleading if the standard search logic in the UCC filing office fails to reveal the Financing Statement when conducting a search using the name.

What about Standard Search Logic?

Suna contended that several searches, by private search companies, using the name “Tyringham Holdings” did produce the UCC filing. However, the court rejected this argument because the relevant search is the one conducted using the UCC filing office’s standard search logic.

Suna also contended that the State Corporation Commission’s search logic was faulty because it did not filter out “Inc.” as a “noise word.”  A noise word includes terms like “an,” “the” and other words that are filtered out when searches are conducted.

The court rejected this argument because the filing office’s standard logic did not consider “Inc.” a noise word. Rather, the standard search logic used by the State Corporation Commission specified that “incorporated” be abbreviated to “Inc.”

Ultimately, the court found that the name was seriously misleading which entitled the debtor to sell the collateral unencumbered by a security interest. Although the court acknowledged that application of the filing office’s standard search logic could result in a minor error preventing perfection of a security interest, the court also reasoned that creditors do not face a significant burden by being forced to use the correct name on UCC filings.

Best Practice

Always always ALWAYS review the public organic record for your debtor. Not only will you confirm the company’s corporate legal name, you will also confirm whether or not the company is in good standing with the state.