Apr 10

The Use of Security Agreements by Trade Creditors – Under Revised Article 9 of the UCC

In an economic climate where a trade creditor is increasingly at risk for payment of goods sold and delivered it makes sound business sense to consider the use of security agreements with new or ongoing customers. A security agreement allows the trade creditor priority status in collection of its receivables where the customer can no longer pay its obligations in the ordinary course of business. It provides protection in both bankruptcy and non-bankruptcy situations.

This article will review the procedures that should be followed by trade creditors who use or wish to use security agreements with assurance that the procedures presently used comply with the new law regarding security agreements and related Uniform Commercial Code financing statements. As a major revision of Article 9 of the U.C.C., which governs security agreements and financing statements comes into effect, in most states on July 1, 2001, it is important to examine procedures for preparing these critical documents.

Security agreements and U.C.C. financing statements must be in compliance with the current rules of the Uniform Commercial Code to be effective. These two documents must be carefully prepared in order to give a trade creditor secured status. A security agreement is similar to a mortgage (in some jurisdictions it is referred to as a “chattel mortgage”); and the financing statement is the document filed to give other creditors and potential creditors notice of the existence of an interest in property of the debtor. Filing of a financing statement without a signed security agreement is ineffective and offers no benefit for the creditor. Likewise, a security agreement without a proper filing of financing statements is subordinate to any creditor who subsequently files correct financing statements, and in some circumstances provides no protection at all.

It is critical that the security agreement and financing statements comply with Article 9 of the Uniform Commercial Code. Under the old Article 9, financing statements were filed wherever the collateral was located. Under the new Article 9, financing statements are filed in the state of incorporation or registration of debtor corporations and limited liability companies. Foreign debtors require a filing in Washington D.C. Where the debtor is unincorporated, filing is where the chief executive officer or principal owner resides or, if there is only one location for a non-incorporated entity, the filing must be where the business is located.

Under the old Article 9, some states, such as New York, required a dual filing with the Secretary of State and in the county in which the assets were located, while the majority of states required a single filing, in most instances, with the Secretary of State. Under the new Article 9, all states that adopt the new Article 9 will use a single filing with the Secretary of State. The new law allows for an “authenticated signature” instead of a manual signature which was required under the old law for financing statements and Continuation Statements.

Under the old Article 9, financing statements expired five (5) years from the date of filing unless a shorter time period was specified. This remains true with the revised edition. The result is that a burden will be placed on creditors and their attorneys during this transition period who must search under the old law and new law for senior security filings in determining credit risk. This burden will continue for five (5) years until security agreements filed under the old law will have all expired. Creditors and their attorneys must also be careful when continuing a security interest in compliance with the new law to do so by filing a Continuation Statement rather than a new financing statement or risk losing priority status.

A security agreement or financing statement filed under the new law, unlike the old, can contain “all asset” language to cover all debtor’s property but must be preceded by the standard categories as defined by the new law. A generic “all assets” listing by itself is not sufficient identification of collateral to comply with the old or new law. In the Security agreement, those categories include (among others) inventory, equipment, accounts receivable, accounts (whose meaning has been expanded under the new law), health care insurance receivables (a new category), commercial tort claims (another new category), leasehold rights (which may not be enforceable depending on the language contained in the debtor’s lease), contract rights, software (new category) and general intangibles (a reduced category as some former items included in the definition of general intangibles have been shifted to accounts under the new law). A creditor may want to also include property that has unique value in its industry, such as prescription records in the pharmaceutical wholesale industry.

The “all asset” language contained in the Security agreement should state, if applicable:

The Borrower acknowledges and agrees that, in applying the law of any jurisdiction that at any time enacts all or substantially all of the uniform provisions of Revised Article 9 of the Uniform Commercial Code (2000 Official Test), the foregoing collateral description covers all assets of the Borrower. The Lender may at any time and from time to time file, pursuant to the provisions of Section [power of attorney provisions], financing and continuation statements and amendments thereto reflecting the same.

In new financing statements the “all asset” language that should be used is as follows:

In applying the law of any jurisdiction that at any time enacts all or substantially all of the uniform provisions of Revised Article 9 of the Uniform Commercial Code (2000 Official Text), the foregoing collateral description covers all assets of the Debtor.

Trade creditors need to be prepared to deal with requests from debtor’s banks or other financing institutions which seek a subordination of the trade creditor’s security interest. Trade creditors should attempt to exclude from subordination the inventory which they provide. Inventory usually has little value to the bank as opposed to the trade creditor and very often banks are willing to forego a priority position in the inventory. In any event, subordination agreements must be reviewed by an attorney and should not be blindly accepted.

The test for the validity of a financing statement is whether a search for the proper name and address would turn up the name used in the filing. If it does, then even a filing that contains a defect in the name would be valid if filed in the proper jurisdiction. The name identifying the debtor should be its proper name without the use of “trading as” or “doing business as” denomination.

Until the new law is in effect for sometime and interpreted by the Courts, we will not be certain how all of these new provisions will be construed. Therefore, it is particularly important that trade creditors and their attorneys remain up to date on all amendments and case law interpretations of the revisions to Article 9, which will surely arise. Trade creditors who have filed financing statements and prepared security agreements in the past, should consult an attorney to insure that the documents test and the filing itself comply with the new Article 9.

– Howard Rubin, Esq.

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