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Indicate Precisely What You Mean to Say: The Importance of Accuracy on UCC-1 Financing Statements

03/18/2020
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UCC-1 Financing Statements are an integral tool in a secured creditor’s toolbox. They perfect a lender’s interest and broadcast notice of this perfected lien to all present or future creditors, putting out the warning that a security interest against the debtor’s collateral exists. An effective financing statement has three requirements: (1) the debtor’s name; (2) the creditor’s name; and (3) a description of the collateral. It may seem simple but failing to meet any of the three requirements renders a financing statement worthless. Even minor errors can be fatal and force the lender out of line, potentially losing all possible recovery. Three recent bankruptcy cases clarify the contours of these requirements, each focused on a different requirement.

Bankruptcy courts are frequently the forum tasked with resolving financing statement disputes. After all, insolvent debtors, limited assets and competing creditors come with the territory. Determining the validity of a lien is explicitly enumerated as a core proceeding under 28 USC § 157(b)(2)(K), meaning Congress bestowed this jurisdiction on bankruptcy courts. Accordingly, a multitude of parties call on bankruptcy courts to carefully scrutinize each of the three requirements, often through an analysis of the controlling state’s statutes. All 50 states have adopted the UCC, but variations exist among the states. And, although bankruptcy is federal law, property rights are drawn from the applicable state law. So, which state’s law controls can dictate the outcome of these cases.

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Requirement 1: The Debtor’s Name

The Case: In Re Preston 2019 Bankr. LEXIS 3864; 2019 WL 7604710, (Bankr. D. Kansas, Dec. 20, 2019).

“A Debtor By Any Other Name Will Not Smell So Sweet to the Lender

In re Preston, a case out of the US Bankruptcy Court for the District of Kansas, highlights the heightened precision required for a debtor’s name. In Kansas, Kan. Stat. Ann. § 84-9-503(a)(4) dictates that the name on a UCC-1 Financing Statement must be identical to the name on the debtor’s driver’s license or state issued identification card. Here, the debtor’s driver’s license bore the name “Preston D Dennis,” without a period after the middle initial. But, the UCC Financing Statement read “Preston D.Dennis” placing a period after the D and no space between the letters. Incidentally both were wrong, the Debtor’s legal name was Dewey Dennis Preston, and he typically went by D. Dennis Preston.

Under Kan. Stat. Ann. § 84-9-506(a) and (b) (Supp.2018), a financing statement which does not use the name of the debtor from the debtor’s driver’s license or identification card is seriously misleading and therefore ineffective to perfect the security instrument.

Here, the creditor knew the debtor’s identity, and the debtor also knew the Financing statement was directed at him. But a financing statement must broadcast notice to other potential creditors. Slight inaccuracies can lead to faulty search results, forcing creditors to play a guessing game on a lien search. Accordingly, even the slightest inaccuracy weakens the efficacy of the statement. Accordingly, the bankruptcy court invalidated the financing statement.

Preston demonstrates that best practice is to review the applicable state law to determine what name needs to appear on the statement. If the law requires it to match the driver’s license, the financing statement must copy this name exactly as it appears on the license. If the license has an error, repeat that error on the financing statement to obtain the desired result. Also, if the Debtor uses multiple names, it behooves a creditor to list all known variations in the room provided on the statement. A little extra time during the statement’s execution can lead to a significant strengthening of a creditor’s rights.

Requirement 2: The Lender’s Name

The Case: In re Jarvis, No. 19-10085, 2020 Bankr. LEXIS 19 (Bankr. W.D.N.C. Jan. 2, 2020).

“Will the Real Secured Creditor Please Stand Up?”

Interpreting Virginia’s Commercial Code, the United States Bankruptcy Court for the Western District of North Carolina ruled a creditor’s lien was invalid due to the financing statement listing the incorrect creditor.

In 2015, Jacob D. Jarvis (the “Debtor”) entered into a Revenue Based Factoring Agreement to borrow $17,000.00 from Strategic Funding Source, Inc. (“Strategic”), also executing a security agreement with Strategic “and its affiliates” pledging certain assets. Strategic listed an affiliated entity, Corporation Services Company (“CSC”) on the financing statement, with no reference to Strategic or any other related entity or affiliate. The Debtor paid the Strategic loan in full.

In 2018, the Debtor entered into another Revenue Based Factoring Agreement to borrow $40,000.00, this time from Money Works Direct, Inc. (“Money Works”), one of Strategic’s affiliates. The Debtor entered into a substantially similar security agreement with Money Works, with the notable exception of Money Works not including its affiliates. Also, no new financing statement was filed, and the 2015 financing statement was not assigned to Money Works. The Money Works loan was unpaid when the Debtor filed his Chapter 13 bankruptcy.

In his petition, the Debtor scheduled an $86,139.02 liability to Money Works as a general unsecured debt. Kapitus Servicing, Inc. (“Kapitus”), which is Strategic’s d/b/a, filed a secured claim, asserting the 2015 financing statement applied to the claim. The Debtor objected to the claim’s secured status.

The bankruptcy court examined In re Adirondack Timber Enterprise, Inc., 2010 WL 1741378 (Bankr. N.D.N.Y. Apr. 28, 2010), which holds that a security agreement by and between a single debtor and a single creditor does not extend any security interests to that creditor’s affiliates. Essentially, only the lender named on the financing statement receives a security interest, and affiliates and subsidiaries do not automatically enjoy secured status due to any relationship with the named creditor. The bankruptcy court sustained the Debtor’s objection, and Money Works lost its secured claim. Had the language on the Strategic security agreement existed in Money Works security agreement, the result may have been different. But the better action would have been for Money Works for file its on financing statement. Its inaction and inattention to detail cost the lender its secured claim.

Requirement 3: The Collateral

The Case: First Midwest Bank v. Reinbold 938 F. 3d 866, (7th Cir. 2019).

I Know What I Know if You Know What I Mean

The third and final requirement, the collateral description, can have decidedly more wiggle room than the naming requirements. Analyzing Illinois law, the Seventh Circuit, in stark contrast to the strict compliance of the first two requirements, held a sparse collateral description merely referencing a security agreement fulfilled the third requirement and made a valid financing statement.

Here, the debtor, I80 Equipment LLC, a company which purchased and refurbished used trucks, entered into a commercial loan with First Midwest Bank, pledging substantially all of its assets as security. The underlying security agreement itemized the collateral with great specificity, dividing the assets into twenty-six separate categories. However, the financing statement’s only description was “all Collateral described in First Amended and Restated Security Agreement date March 9, 2015 between Debtor and Secured Party.”

The chapter 7 trustee took issue with this vaguery and attacked First Midwest’s lien. The bankruptcy court approved, ruling the lack of description “fails to give the particularized kind of notice” required in a financing statement.

Given the strict interpretations of names, this result seems eminently reasonable. And, before the 2001 amendment to Illinois’ statute, the financing statement would have been deficient. But, on direct appeal, the Seventh Circuit, parsing the Illinois statute, reversed the bankruptcy court’s ruling.

810 ILCS § 9-502, as amended, once required a financing statement to “contain a statement indicating the types, or describing the items of collateral” but now only requires it to “indicate the collateral covered by the financing statement[.]” The Court explored the common definition of indicate, finding it synonymous to “point[ing] out[.]”  Also, § 9-108 provides six ways to “indicate:” (1) specific listing; (2) category; (3) type; (4) quantity; (5) mathematical computation or allocation; or (6) any other method, if the identity of the collateral is objectively determinable.

The Court found that First Midwest Bank fit § 9-108’s final catchall. While financing statements and security agreements both must describe the collateral, they require different levels of precision. Again, since the purpose of the financing statement is to put future creditors on notice, once the lender and the borrower are properly identified, the statute puts the onus on a future creditor to determine the collateral. If the financing statement only contains a reference to a security agreement, the creditor must take the necessary step to request the agreement to properly identify the impaired collateral before extending the lender any credit. Accordingly, the security agreement should always be at the highest level of precision. But, once that detail is accomplished, a mere reference in the financing statement will suffice.

Lessons Learned:

As demonstrated by these cases, lenders can suffer greatly from unforced errors in a financing statement. These cases instruct lenders how to avoid these pitfalls, and simultaneously provide debtors with a roadmap on how to attack secured claims. When preparing a financing statement, always consult the state statute, and err on the side of caution with names. List multiple names where appropriate. Relying on a reference to a security agreement is permitted under certain statutes, but, when employing this method, make sure the security agreement describes the collateral in the greatest possible detail. After closing a loan, filing the correct financing statement may seem like the easy part, but failure to pay close attention to details can entirely wipe out the lender’s rights. Make sure to finish the transaction strong with an airtight financing statement.

Please contact Rick S. Rein and Nathan E. Delman with questions.

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