Magazine article Journal of Commercial Lending

The 45-Day Rule: A Primer for Avoiding Contests over Collateral

Magazine article Journal of Commercial Lending

The 45-Day Rule: A Primer for Avoiding Contests over Collateral

Article excerpt

Evelyn Waugh Wood was a seasoned commercial loan officer and a good one at that. Wood came from a family of fast reading bibliophiles. To compensate for her name regularly causing her to be mistaken for someone else (she was related to no one famous), Wood worked hard at being factual and precise. She knew how to secure a customer's collateral; she dotted all the i's and crossed all the t's; she had not encountered any problems with the federal government.

Wood had once heard of the 45-day rule but had long since put it in the back of her mind. Then one day, the 45-day rule reared its persnickety little head and blindsided her.

Background Events

Wood handled Loredo Enterprises, Inc., a company specializing in quality western wear. Loredo, a long-standing customer of the bank with a good track record of aggressive borrowing and timely repayment, had outstanding term loans and a substantial line of credit with Wood's bank. The bank secured its position with Loredo's property, including its accounts receivable. The dollar amount of the receivables was significant.

When the company informed Wood that it was having a tax dispute with the Internal Revenue Service (IRS), Wood was not concerned. Loredo had retained respectable tax counsel, and in Wood's view, the dollar amount of the dispute, while large, did not pose a threat to the bank. First, Wood believed Loredo could pay the tax. Second, the bank was secure and had a priority that dated back years before the tax dispute. In Wood's mind, there was no possible way the bank was at risk.

Wood was wrong. Loredo stopped making payments on its loans about the same time the IRS issued levies against all of Loredo's accounts receivable. A contest ensued. Wood then learned that the IRS had filed a notice of federal tax lien against Loredo more than 45 days before it had issued the levies. The bank's attorney gave Wood and the bank the bad news: The IRS lien trumped the bank's secured position. When Loredo was forced to close, it was the IRS that took the receivables.

Wood felt defeated, but based on the many cases in the legal literature, she was not the first. The 45-day rule points to a peril that all financial institutions and loan officers face. To be forewarned about this rule is to be forearmed.

The 45-Day Rule

When an assessment is made against a taxpayer, a statutory lien arises in favor of the federal government. The lien attaches to all property or rights to property belonging to the taxpayer. This lien is called a "silent" lien because it comes into existence without notice to the world. The lien, however, does not entitle the IRS to priority against most other secured parties unless the IRS files a notice of federal tax lien. The place of filing is the one office within the state (or county or other government subdivision, if applicable) that is designated as such by the laws of the state in which the property subject to the lien is situated.

Place to File

In the case of real property, the proper place to file is usually the deed filing office in the county in which the property is located. In the case of personal property, whether tangible or intangible, the proper place to file usually is a designated office in the county in which the taxpayer resides. If the taxpayer is an entity, the proper office often is the secretary of state.

The 45-day rule gives the IRS special rights against lenders that secured themselves with their customers' collateral. The rule, which appears in Section 6323(d) of the Internal Revenue Code, (26 U.S.C.) states as follows:

Even though notice of a lien imposed by section 6321 has been filed, such liens shall not be valid with respect to a security interest which came into existence after the tax lien filing by reason of disbursements made before the 46th day after the date of tax lien filing, or (if earlier) before the person making such disbursements had actual notice or knowledge of tax lien filing, but only if such security interest (1) is in property (A) subject, at the time of tax lien filing, to the lien imposed by section 6321, and (B) covered by the terms of a written agreement entered into before tax lien filing, and (2) is protected under local law against a judgment lien arising, as of the time of tax lien filing, out of an unsecured obligation. …

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