Right on the Money

Article excerpt

Uniform Commercial Code revisions affect how banks document and issue loans

Article 9 of the Uniform Commercial Code, which governs the creation of security interests in personal property and delineates the rules and procedures for a bank to obtain personal property collateral for a loan, has been substantially revised. Those revisions, adopted by roughly 29 states as of January, will impact the manner and method in which banks document and process loans secured by personal property, making life simpler for secured lenders in commercial transactions.

The UCC, which establishes a series of legal rules for various types of commercial and consumer transactions, has eleven substantial articles, of which Article 9, is just one. This article highlights only certain areas of Revised Article 9 that may impact typical secured lending practices. It focuses on Article 9 and its concepts of "attachment" (when security interests are effective between creditors and debtors as stated in their agreements) and "perfection" (when creditors establish their priority relative to other creditors) in regards to collateral.

After more than five years in the making by national standard-setting organizations, the revisions are set to take effect July 1, 2001, subject to adoption by individual states. This date was intended to give all states ample opportunity to enact the new statute to avoid complications over such matters as where litigation regarding collateral is heard. This is important because the legality of such secured interests will be affected by which version of Article 9 is in effect, depending on whether the state has enacted the newest version or relies on the current article.

Foremost, the revisions expand the types of collateral in which a debtor can grant a security interest, allowing deposit accounts, for example (excluding consumer deposit accounts), to now be included. Revised Article 9 also permits electronic transactions, whereas before a security agreement had to be signed by the "debtor."

Perfection of security interests under Revised Article 9 will generally be accomplished either by filing a UCC-1 financing statement, by "control" or both.

Perfection by Control

If the collateral consists of investment property (commodity accounts, securities, mutual funds) or deposit accounts, you should perfect your security interest by control. Control normally means the use of a three-party agreement. For example, if the collateral is investment property, the control agreement would normally be an agreement between the bank, the debtor and the securities or commodities broker.

The control agreement should provide for the granting of the security interest and should further provide that upon notice from the bank, the broker will liquidate the positions and forward all net funds to the bank.

A security interest in investment property can be perfected by filing. However, if Bank A perfects only by filing and Bank B perfects by control, then Bank B has priority. Accordingly, both filing and control should perfect these interests.

Control is also required to perfect a security interest in deposit accounts. If the deposit account is with the bank that has the security interest, then no control agreement is required, as control-perfection is automatic. However, if the account is at Bank A, then Bank B would need a control agreement.

In such a scenario, Bank B,which does not hold the account would need to enter into an agreement that essentially states that upon notice, Bank A would forward the funds in the deposit account to Bank B without obtaining further consent from the debtor. Bank A's right of set-off, however, retains priority over the security interest of Bank B.

Generally, the priority between competing secured creditors under Revised Article 9 is still based upon a "first to file rule." Revised Article 9 does provide, however, certain purchase money exceptions. …