Security Interests – Imperfect Perfection

A Short Series On Security Interests For Credit Managers

Part 4: Imperfect Perfection

by Robert S. Bernstein, Esquire
Bernstein-Burkley, P.C.

Last week, we used this simple example of perfection by filing:

You sell equipment on credit to a customer who only has one location, in Pittsburgh, Pennsylvania. That customer is a Rhode Island corporation. Customer signs an agreement granting you a security interest in that equipment. Under Revised Article 9 (R9), the customer no longer has to sign UCC-1 forms. These forms are filed without a signature. Under former Article 9, you would have needed the signature and had to file the financing statements with the Secretary of the Commonwealth of Pennsylvania, since the property is located in PA. You would also have needed to file with the Prothonotary (Clerk) of the Court of Common Pleas of Allegheny County, since the customer operated only in one county in PA. Now, under R9, that is all different. Since the customer is a Rhode Island corporation, you only need to file the financing statement in Rhode Island!

I said there were things that could go wrong. Let me highlight a few. The first has to do with the accuracy of the debtor’s name. Anyone who has tried to collect an account knows how important it is to get the customer’s name and legal composition right. It is critical here. If your customer is Bob Bernstein trading as Bob’s Barrels (sole proprietorship), your filing should not be against “Bob’s Barrels.” Under R9, your filing is not “seriously misleading” if the filing office’s computer search logic will find the filing. It is unlikely that a search for “Bernstein, Bob” would turn up a filing against “Bob’s Barrels.” In that event, your filing would not be good.

That is not the name of the owner of the equipment you sold. Someone searching for liens against Bob Bernstein would not find it if filed against Bob’s Barrels. Likewise, if Bob was the sole shareholder of Bob’s Barrels, Inc., you would not file against Bob Bernstein, since someone searching for Bob’s Barrels, Inc., would not find it.

The other critical item under R9 is making sure of the “location” of the debtor, if a registered entity. You will need to verify the state of incorporation and get the entity number that the state issued. That number needs to be on the financing statement or it may be rejected by the filing office.

If you were selling inventory (a UCC defined term) instead of equipment, you could have a more serious problem. The UCC allows that a perfected filing against inventory can cover “after acquired” inventory. So, if Bob was in the business of retailing barrels and you sold him barrels, those barrels would become part of his inventory. Let’s say that Local Bank previously loaned Bob working capital and that it has a perfected security interest in his inventory (along with everything else). Even if you have a purchase money security interest (where you provide the credit for the purchase), you may be junior to Local Bank, unless you have done some work in advance of delivering the barrels.

Without more work, as soon as Bob gets your barrels, the security interest of the bank attaches (grant of the security interest in writing, value given and now debtor has rights in the collateral). Without more work, the Bank now has a senior lien on your barrels and you may be in trouble.

The UCC provides a mechanism for you to give notice to a prior perfected security interest holder in inventory that you intend to ship and take a purchase money security interest in certain goods. If you do that, your lien can become the senior lien on your inventory. Let me give a story that pulls much of this together.

A number of years ago, there was a lawn tractor dealer in our area. Its physical address was in Westmoreland County Pennsylvania, which we will call Bob’s, Inc. It used a mailing address of a Post Office Box in Monroeville (Allegheny County). It has pledged its entire inventory to a bank, who properly filed financing statements. A vendor intended to sell $400,000 of inventory to the dealer and searched the records of the State and Allegheny County for Bob’s, Inc. of P.O. Box xxx, Monroeville. The search turned up nothing, since all of the other filings were using the physical address.

The vendor sold and shipped and did file UCC-1 forms in Allegheny County, with the Commonwealth, and in Westmoreland County. Bob’s, Inc. later filed bankruptcy. Vendor lost its $400,000. Even though it was lucky enough to have filed in the right places, it did not give notice to the prior perfected lien holder that it was putting inventory in under a security interest. Thus, the bank’s lien attached before the vendor’s.

Next time, some simple steps to avoid problems when retaining (or taking) security interests.

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