Right on the Money
Turner, Steven, Independent Banker
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.
For example, if Bank A has a security interest in all the debtor's equipment, Bank B can make a loan to the debtor for the purpose of acquiring a new specific item of equipment and obtain priority over Bank A. In such a scenario, Bank B also must have filed a UCC-1 financing statement either before the debtor receives possession of the equipment or within 20 days thereafter.
Perfection by Filing
A change to Article 9 also will affect where a UCC-1 financing statement is filed. Under current code, the location or place of filing sometimes depends upon the location of the debtor and other times depends upon location of the collateral. Under Revised Article 9, however, the "location" of the debtor determines the place of filing.
If the debtor is an individual, then the filing will be made in the state of the debtor's location. If the debtor is a legal entity, then filing should be made in the state in which such entity was registered or formed.
Revised Article 9 also addresses "transitions" to new filing locations, for loans made previous to the revisions becoming effective. Under the transition rules, any prior filings remain effective from the date of inception for five years. The UCC filing would then have to be transferred to reflect the company's state of formation at the time of renewal.
As under old Article 9, a UCC-1 financing statement must describe the collateral and the general rule is the collateral description in the UCC-1 financing statement should replicate the description in the security agreement. Although, under Revised Article 9, the security agreement must describe the types of collateral, it is sufficient to list in the UCC-1 financing statement "all assets" or "all personal property."
The revisions also outline procedures with regards to defaults. If after default the bank obtains possession of the collateral and the bank wants to sell the collateral, the bank is required to send the debtor, all guarantors and any other secured party of record a notice of any public or private sale. Revised Article 9 contains a safe harbor notice of sale form for both consumer and nonconsumer transactions.
If the bank fails to give notice or does not dispose of the collateral in a commercially reasonable manner, then Revised Article 9 provides for a legal presumption that the value of the collateral sold was equal to the debt. Unless the bank can rebut this presumption, then it will lose any deficiency claim against the debtor or any guarantor.
Revised Article 9 also contains a series of rules relating only to consumer transactions. For example, the collateral descriptions in the security agreement and financing statement must be specific (such as a motor vehicle).
In addition, the consumer "safe harbor" notice of sale of collateral form requires additional information. If after any disposition of collateral there is a deficiency, then the secured party is required to send a further notice to a consumer explaining the calculation of the deficiency.
As in any substantial change in the law, there will always be a period of "confusion." However, once that period passes, in general, Revised Article 9 should add greater certainty and precision to documenting and perfecting loans secured by personal property.
However, while the UCC is supposed to be uniform throughout all 50 states, some states that have adopted Revised Article 9 have adopted some variations. Accordingly, it is necessary to look at the specific state's adoption of Revised Article 9 in terms of each bank's lending practices.
Article 9 Revisions on Agricultural Financing
Under Revised Article 9, the definition of farm products has changed. The general focus of Revised Article 9 is that if the debtor is engaged in a farming operation, which does not mean the sole or exclusive business operation of the debtor, then the goods would constitute farm products as distinct from inventory.
The prior definition of farm products did not specifically include aquatic goods and included the concept that farm products must be in the possession of the debtor to be deemed as such.
The changes in the UCC code also make it clear that Revised Article 9 controls any issue of priority between a bank financing a farmer's crops and the lender financing the real estate. They generally provide that the bank financing the crops has priority over the real estate lender.
A significant change in Revised Article 9 is the inclusion of agricultural liens within the scope of Article 9 for purposes of perfection, priority and enforcement. Revised Article 9 does not create an agricultural lien, but simply recognizes agricultural leins to the extent that other state law has created them.
An agricultural lien is an interest in farm products which secures:
* the payment or performance of an obligation for goods or services furnished in connection with the debtor's farming operation; or
* rent on real property leased by the debtor in connection with a farming operation.
Agricultural liens would include, for example, a fertilizer lien, seed lien, harvesting lien or any other lien provided by state law to the suppliers of agricultural inputs or agricultural service providers.
For an agricultural lien to be perfected, the lien holder must file a UCC-1 financing statement in compliance with the provisions of Revised Article 9. Unlike the general rule in Revised Article 9 where the debtor's location controls the place of filing, it is the location of the farm products subject to the agricultural lien that determines the appropriate filing office.
Accordingly, agricultural banks may have to do UCC searches in multiple jurisdictions. For example, Green Acres Inc. is an Illinois corporation that raises corn in Iowa. Any UCC-1 financing statement relating to a security interest would be filed in Illinois, whereas any agricultural lien would be filed in Iowa.
As a general rule, agricultural liens are subject to the "first to tile rule" of pri
ority. However, if the statute which creates the agricultural lien specifies that it has priority interest of other agricultural liens, then that statute controls priority. Agricultural liens are also subject to the rights and obligations of any secured party upon default.
Revised Article 9 as it relates to agricultural lending also includes a purchase money proirity for livestock financing. A perfected purchase money security interest in livestock that are farm products has priority over a conflicting security interest in the same livestock if:
* the purchase money security interest is perfected when the debtor receives possession of the livestock;
* the purchase money secured party has sent a notificaiton to the holder of the prior conflicting security interest;
* the holder of the prior conflicting security interest receives the notification within six months before the debtor receives possession of the livestock; and
* the notification states that the purchase money secured party has or expects to acquire a purchase money security interest in livestock of the debtor and describes the livestock. The purchase money priority extends to the livestock, as well as, all identifiable proceeds and products.
Steven Turner is a bank lending and bankruptcy partner in the law firm of Baird, Holm, McEachen, Pedersen, Hamann & Strasheim LLP in Omaha, Neb. Reach him via e-mail at firstname.lastname@example.org.…
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Publication information: Article title: Right on the Money. Contributors: Turner, Steven - Author. Magazine title: Independent Banker. Volume: 51. Issue: 3 Publication date: March 2001. Page number: 64+. © 2002 Independent Banker. Provided by ProQuest LLC. All Rights Reserved.
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