By A. Anthony Rohach, Esq.
Part Two of a Three Part Series.
In Part One, I mentioned that the creditor can and probably should “put the world on notice” of a security interest. The reason that a creditor wants to do this is because it tends to prevent “opportunistic behavior” by the debtor and secures the rights that a creditor has to have their loan repaid through the disposition of the “collateral”.
For example, if a debtor uses a piece of personal property (or if a business uses its “personal property”) as collateral to secure a loan from Bank “A” by granting Bank “A” a security interest, absent a notice system, nothing prevents the debtor from going right down the street to Bank “B” and doing exactly the same thing. If there is no objective, reliable source of information to consult, Bank “B” may very well grant the debtor a loan using the same property as collateral because they would not necessarily realize the existence of Bank “A’s” security interest. If the debtor defaults on either loan or worse files for bankruptcy protection, which creditor, Bank “A” or Bank “B”, gets to enforce their security interest? Without some rules and a system to manage or prevent this kind of situation, this type of asset-based lending might not be offered by any creditor. Then everybody loses.
The issues this hypothetical exposes are “perfection” and “priority.”
Perfection
Usually, “perfection” of a security interest means that the appropriate paperwork is filled out properly and is filed correctly with any given state’s corporation or business bureau’s public search process. Ordinarily, in Pennsylvania, in order to “perfect” a security interest, the creditor needs to fill out a UCC-1 financing statement, although certain exceptions exist such as perfection by either control or possession of the collateral by the creditor. When filling out the UCC-1 document, the description of collateral is very important in order for the security interest to be enforceable, as is the proper name of the debtor.
The description of the collateral must fit into one of several identifying types such as specifically listing the collateral (like a “vin” number for a car); category (like inventory or equipment) or any other method that can be used to objectively and reasonably identify the collateral. So called “supergeneric” descriptions such “all the debtor’s assets” or “all the personal property of the debtor” cannot be used to reasonably identify collateral. Such supergeneric descriptions may invalidate the filing and can have serious consequences.
Additionally, UCC-1 documents are usually indexed by the debtors name. It is important that the proper name of the debtor is used on the UCC-1 so when indexed, subsequent creditors can find the document. This can be problematic if the debtor is actually a business, but the debtor identified on the UCC statement is a natural person, or vice versa. Such an improper indexing can also have serious consequences for the creditor and may invalidate the filing.
Priority
Priority refers to the methodology used to resolve potential disputes between different types of creditors in the event of default or a filing of bankruptcy by the debtor. The different types of creditor groupings are perfected secured creditor, secured creditor and unsecured creditor. How a creditor is ultimately found to be categorized is critical to determining whether or not that creditor will be able to use the collateral bargained for in the security agreement to liquidate and apply any funds from the sale to their loan exclusively.
Anthony Rohach is a Pennsylvania attorney located in Doylestown, Bucks County. If you would like to consult with Mr. Rohach send him an email at aar@timbyhunt.com or call him at (215) 230-7626.
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