Magazine article Business Credit

Certificateless and Non-Negotiable Certificates of Deposit as Pledged Collateral: Don't Bet on It!

Magazine article Business Credit

Certificateless and Non-Negotiable Certificates of Deposit as Pledged Collateral: Don't Bet on It!

Article excerpt

A creditor with a security interest in a certificate of deposit believes that it has highly liquid collateral to secure payment of its claim. However, the creditor's security interest must be perfected in order for the creditor to have priority over the interests of a competing lienholder, such as a judgment creditor or bankruptcy trustee. As a result of a number of recent court decisions, a secured creditor should not take it for granted that it has obtained a perfected security interest in a certificate of deposit pledged as collateral. If a secured creditor does not have a perfected security interest in the CD, the CD will be an unencumbered asset available for distribution to all of the debtor's unsecured creditors.

What Is a Certificate of Deposit?

A secured creditor must first determine the category of collateral to which a certificate of deposit belongs in order to determine the proper means of perfecting a security interest in the CD, which may not be so clear. Section 3-104(10) of the Uniform Commercial Code defines a certificate of deposit as "an instrument containing an acknowledgment by a bank that a sum of money has been received by the bank to repay the sum of money. A certificate of deposit is a note of the bank." UCC Section 9-105(1)(i) defines an instrument as either (a) a negotiable instrument or a certificated security, or (b) any other writing that evidences a right to the payment of money (other than a security agreement or lease) if that writing "is of a type which is in the ordinary course of business, transferred by delivery with any necessary endorsement or assignment."

Under existing UCC Article 9, if a certificate of deposit is an instrument, a security creditor can perfect a security interest only by possession. Under Revised Article 9 of the Uniform Commercial Code, which will take effect in many states on July 1, 2001, a secured creditor can perfect a security interest in a certificate of deposit by either taking possession of the CD or filing a UCC financing statement. However, even under Revised Article 9, the preferred method of perfecting a security interest in a CD will continue to be by possession.

Two issues have arisen with respect to a certificate of deposit pledged as collateral. How can a creditor obtain a perfected security interest in a paperless certificate of deposit where the bank did not issue an instrument to evidence the CD? And is a non-negotiable and non-transferable certificate of deposit an instrument or a general intangible? The distinction is critical for purposes of perfecting a security interest in the CD under UCC Article 9. If the CD is an instrument, a secured creditor can perfect a security interest only by possession under existing Article 9, and perfection by possession remains the preferred method of perfection under Revised Article 9. If the CD is a general intangible, a secured creditor can perfect a security interest only by filing a UCC financing statement--possession alone just will not do!

The following cases show the importance of a secured creditor properly categorizing a certificate of deposit and then perfecting a security interest in the CD in the manner required for that particular category of collateral. If a secured creditor fails to do this, the certificate of deposit will be unencumbered and available for distribution to all of the debtor's unsecured creditors.

In Re Alabama Land and Mineral Corp.--The Case of the Certificateless Certificate of Deposit

In In re Alabama Land and Mineral Corp., the bank had issued a standby letter of credit in the amount of $1 million for the account of the letter of credit applicant. The applicant had agreed to reimburse the bank for all of the bank's payments made on account of draws under the letter of credit.

The bank believed that it had secured payment of the applicant's reimbursement obligation to the bank by the deposit of $1 million with the bank. …

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