Continuing Perfection During Bankruptcy Under Revised Article 9

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Apr 2001

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In many ways, revised Article 9 simplifies life for secured creditors. This is
particularly true with respect to most of the act's bankruptcy implications, which have
been the subject of these columns. However, one change in the revision will impose
new bankruptcy-related duties on secured creditors.

Under current law, the pendency of a bankruptcy or other insolvency proceeding
freezes the perfected status of the security interest during the case. If the normal
five-year term of the financing statement expires during bankruptcy, the secured
creditor is relieved of the duty to continue its financing statement until 60 days
after termination of the insolvency proceeding.<a href="#1" name="1a">1</a>

The revised act eliminates this rule.<a href="#2" name="2a">2</a> Bankruptcy no longer tolls the expiration
of the financing statement. Thus, for financing statements expiring after July 1,
2001, secured creditors must file continuation statements before the financing
statement lapses, even if the debtor is in bankruptcy.

<h3>A Little Background</h3>

Under current law, a financing statement perfects a security interest for five years
from the date of filing.<a href="#3" name="3a">3</a> If the secured party wishes to maintain perfection beyond
the five-year period, a continuation statement must be filed within six months prior
to the expiration of the five-year period.<a href="#4" name="4a">4</a> If the continuation statement is not
filed during the 4 1/2 to 5-year window,<a href="#5" name="5a">5</a> then the financing statement lapses
upon the expiration of the five-year period, and the security interest becomes
unperfected.<a href="#6" name="6a">6</a>

However, current Article 9 tolls the expiration of the financing statement during
the pendency of a bankruptcy or other insolvency proceeding. Thus, if the security
interest is perfected by filing at the time a bankruptcy proceeding is instituted,
it remains perfected until, at the earliest, 60 days after termination of the
bankruptcy proceeding.<a href="7" name="7a">7</a> While current Article 9 permits the secured creditor to file
a continuation statement within the usual six-month period if it wishes, the
insolvency tolling rule makes it unnecessary for the secured party to take any action
in order to maintain perfection during a bankruptcy proceeding.

Initially, it was not clear whether the §362 automatic stay<a href="#8" name="8a">8</a> prevented the
filing of a continuation statement during a bankruptcy case. Several cases addressing
this issue drew a distinction between acts to perfect a lien and acts to maintain the
perfection of a lien.<a href="#9" name="9a">9</a> Under this view, a secured creditor wishing to file a
continuation statement during a bankruptcy case and within the usual six-month window
did not need to first obtain an order lifting the stay.

With the 1994 amendments to the Bankruptcy Code,<a href="#10" name="10a">10</a> it became clear that the
filing of a bankruptcy did not prevent a secured creditor from filing a continuation
statement. Following the developing case law, Congress amended §§362(c)(3) and
546(b) to create an express exception to the automatic stay for acts to maintain
or continue the perfection of an interest in property.<a href="#11" name="11a">11</a> As a result of this
amendment, one of the primary justifications for the insolvency tolling rule was
eliminated.

In addition, the rule created practical problems for the UCC filing offices.
Since the filing office was permitted to remove and destroy financing statements one
year after lapse,<a href="#12" name="12a">12</a> non-continued statements could be destroyed after six years.
If the filing office was not advised of a pending bankruptcy proceeding, a
six-year-old financing statement might be destroyed even though the tolling rule had
prevented it from lapsing.<a href="#13" name="13a">13</a> As a result, the continuation statement filed after
termination of the bankruptcy proceeding might refer to a financing statement that no
longer existed.

<h3>Lapse Waits for No Bankruptcy</h3>

The revised act simply deletes the tolling rule. Instead, it requires in all cases
that continuation statements be filed "only within six months before the expiration of
the five-year period."<a href="#14" name="14a">14</a> Thus, after the revised act's July 1, 2001, effective
date, a secured creditor must file a timely continuation statement if it wishes to
maintain perfection and to preserve the priority position established by its initial
financing statement.<a href="#15" name="15a">15</a>

What is the effect of a failure to file a timely continuation statement to
continue the initial filing? Revised Article 9 modifies the current lapse rule to
limit the retroactive effect of the lapse of a financing statement. The revision
carries forward the current rule that the security interest becomes unperfected upon
lapse.<a href="#16" name="16a">16</a> Thus, the security interest would be subordinate to a lien creditor who
acquires its lien after the lapse and could be avoided under the §544(a)(1)
"strong-arm power" in a bankruptcy filed after the lapse.

However, with respect to the retroactive effect of lapse, the revision deletes the
words "lien creditor" from the current rule. Thus, if the financing statement lapses,
the security interest "is deemed never to have been perfected as against a purchaser
of the collateral for value."<a href="#17" name="17a">17</a> Since the term "purchaser" includes a secured creditor
but not a lien creditor, the lapse is retroactive only as to purchasers and secured
creditors.<a href="#18" name="18a">18</a>

Since the §544 strong-arm power gives the trustee the status of a lien creditor
with respect to the debtor's personal property, the §9-515(c) limitation should
prevent the trustee from avoiding a personal property security interest based on a
post-petition lapse of perfection. But, since the trustee is given bona fide
purchaser status with respect to real property, §9-515(c) may not have that
effect with respect to real estate-related interests like fixtures.

However, that result would be inconsistent with the majority view under the case
law dealing with post-petition lapse. Although this issue does not arise under the
current version of Article 9 because of the insolvency tolling rule, the prior
1962 version of Article 9 did not include an insolvency tolling rule. The cases
decided under the 1962 version of Article 9 split, with a few cases holding
that the secured creditor's failure to file a continuation statement post-petition
destroyed the security interest.<a href="#19" name="19a">19</a> However, most cases adopted the view that the
bankruptcy filing freezes the secured creditor's status as of the petition date.<a href="#20" name="20a">20</a>

Thus, since the trustee's strong-arm power was measured as of the petition date,
the post-petition lapse could not be used to avoid a security interest that was
properly perfected as of the petition date.

Even though the trustee may not be able to take advantage of a post-petition lapse
in perfection, a secured creditor who fails to timely file a continuation statement
runs the risk that a third party may prime its lien. Under §9-515(c), a junior
secured creditor might be able to take advantage of the post-petition lapse, unless
the courts apply the "bankruptcy freeze" logic to all competing parties rather than just
the trustee. A more significant threat will come from parties who deal with the
debtor post-petition. While the likelihood of this occurring is small in a liquidation
case, it is much greater in a reorganization case where the debtor retains the
collateral and continues to operate its business.

In such a case, a trustee might even be able to avoid the security interest.
For example, in <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… Electric Credit Corp. v. Nardulli & Sons Inc.,
836 F.2d 184, 192 (3d Cir. 1988)</a>, the secured creditor failed
to re-file a financing statement in the new state when the debtor moved its chief
executive office after the chapter 11 plan was confirmed. When the plan failed and
the case was converted, the chapter 7 trustee attempted to use the strong-arm power
to avoid the security interest. The court rejected that attempt because the petition
date of the original chapter 11 case was the relevant date for measuring the
strong-arm powers of the trustee in the post-conversion chapter 7 phase of the
case. While the secured creditor prevailed in Nardulli, note that the lien could
have been avoided by the trustee if, instead of converting to chapter 7, a new
bankruptcy had been filed.

<h3>Enactment Update</h3>

No additional states have enacted revised Article 9 since the last issue. Thus,
as of early March, only 28 states plus the District of Columbia have adopted
revised Article 9. The act has been introduced in six new states, including New
York and Pennsylvania, and revision bills are pending in 18 states plus the U.S.
Virgin Islands.

<hr>

<h3>Footnotes</h3>

<a name="1">1</a> See current §9-403(2). All citations are to the revised 1999 version of Article 9 of the Uniform Commercial Code, unless
otherwise indicated. Citations to the currently applicable 1972 version of Article 9 are indicated by the term "current." <a href="#1a">Return to article</a>

<a name="2">2</a> Compare current §9-403(2) with §9-515(d); see, also, §9-515, cmt. 4. <a href="#2a">Return to article</a>

<a name="3">3</a> See current §9-403(2). <a href="#3a">Return to article</a>

<a name="4">4</a> See §9-403(3). <a href="#4a">Return to article</a>

<a name="5">5</a> A continuation statement filed either before or after the six-month window is ineffective. See Hawkland, Lord & Lewis UCC Series
§9-403:4, pp. 9-572-73 (Art 9, 1997). <a href="#5a">Return to article</a>

<a name="6">6</a> See current §9-403(2) and (3). Current §9-403(2) provides that, "Upon lapse, the security interest becomes unperfected,
unless it is perfected without filing. If the security interest becomes unperfected upon lapse, it is deemed to have been unperfected as against
a person who became a purchaser or lien creditor before lapse." Since the term "purchaser" includes an Article 9 secured party [see

§§1-201(32) and (33)], this provision has the effect of rendering the security interest unperfected both prospectively and
retroactively. <a href="#6a">Return to article</a>

<a name="7">7</a> See current §9-403(2). If the original five-year period is longer than this 60-day period, then the security interest remains
perfected for that longer period. Id. <a href="#7a">Return to article</a>

<a name="8">8</a> See <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… U.S.C. §362(a)(4)</a> and (5). <a href="#8a">Return to article</a>

<a name="9">9</a> See <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… Deere Co. v. Alamosa Nat'l Bank, 786 P.2d 505, 506 (Colo. App. 1989)</a>; cf. <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Larson, 979
F.2d 625, 627 (8th Cir. 1992)</a> (addendum to mortgage); but, see <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Bond Enterprises Inc., 54 B.R. 366
(Bankr. D. N.M. 1985)</a> (dicta); see, generally, <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…, John C., Some Bankruptcy Stay Metes and Bounds, 99 Comm. L.J.
301, 310-11 (1994)</a>. <a href="#9a">Return to article</a>

<a name="10">10</a> See Bankruptcy Reform Act of 1994, §204. <a href="#10a">Return to article</a>

<a name="11">11</a> See <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… U.S.C. §§362(c)(3)</a> and 546(b). <a href="#11a">Return to article</a>

<a name="12">12</a> See current §9-403(3) and current §9-403, cmt. 2. <a href="#12a">Return to article</a>

<a name="13">13</a> See §9-515, cmt. 4. <a href="#13a">Return to article</a>

<a name="14">14</a> See §9-515(d). Note that although the five-year rule applies to the great majority of transactions, financing statements filed for
public-finance or manufactured-home transactions are effective for 30 years. See §9-515(b). In addition, financing statements filed
for transmitting utilities and mortgages filed as fixture filings are effective indefinitely. See §9-515(f) and (g). <a href="#14a">Return to article</a>

<a name="15">15</a> Note that if the original financing statement was filed under current Article 9, the revised act's transition rules may impose special
requirements on a continuation statement filed under revised Article 9. For example, the revised act requires that most financing statements
be filed in the debtor's state of incorporation, whereas current law requires that the financing statements be filed in the state where either
the collateral or the debtor's chief executive office is located. Compare current §9-103(a) and (c) with §§9-301 and
9-307(b). Thus, the continuation statement may need to be filed in a state different from the state in which the original financing
statement was filed. In such cases, the revised act requires the filing in the new state of an "initial financing statement in lieu of a
continuation statement." See §§9-705(d) and 9-706(a). This record must identify the pre-revision financing statement and indicate
that it remains effective. Unlike a normal continuation statement, such a statement may be filed at any time during the five-year life of
the original financing statement. See §9-706(b) and (c). <a href="#15a">Return to article</a>

<a name="16">16</a> Section 9-515(c) states, in part, "Upon lapse, a financing statement ceases to be effective, and any security interest or
agricultural lien that was perfected by the financing statement becomes unperfected..." <a href="#16a">Return to article</a>

<a name="17">17</a> §9-515(c). <a href="#17a">Return to article</a>

<a name="18">18</a> Note that the "for value" restriction will not exclude any Article 9 secured creditors because secured creditors give value by definition
when they obtain a security interest. See §1-201(44)(b). <a href="#18a">Return to article</a>

<a name="19">19</a> See <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Radcliff Door Co. Inc., 17 B.R. 153, 156 (Bankr. W.D. Ky. 1982)</a>. <a href="#19a">Return to article</a>

<a name="20">20</a> See, e.g., <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… of Chaseley's Foods Inc., 726 F.2d 303, 304, 308 (7th Cir. 1983)</a>; <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Catamount
Dyers Inc., 50 B.R. 788, 790 (Bankr. D. Vt. 1985)</a> (citing cases); cf. <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Halmar Distribs. Inc., 968
F.2d 121, 127-28 (1st Cir. 1992)</a> (bankruptcy freezes matters so post-petition interstate moves do not require refiling under
§9-103). <a href="#20a">Return to article</a>

<hr>

Journal Authors

G. Ray Warner

Journal Date

Sunday, April 1, 2001 - 12:00

Bankruptcy Rule

2001