Using the Strong-arm Power to Attack Name Errors Under Revised Article 9

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Oct 2001

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As discussed in earlier columns, most of the changes introduced by the Article 9
revision will make it more difficult for security interests to be avoided in bankruptcy.
However, one area where that is not the case is the new standard for measuring whether
a financing statement sufficiently lists the name of the debtor. The new legal standard,
coupled with strict search logic standards being adopted by filing offices, should make
it much easier to challenge the perfection of a security interest on the basis of minor
errors in the debtor's name.

<h3>The Strong-arm Power and Financing Statement Errors</h3>

The <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…;§544(a)(1)</a> "strong-arm" power<a href="#2" name="2a">2</a> gives the trustee in bankruptcy the status
of a judicial lien creditor as of the petition date and allows the trustee to avoid
any Article 9 security interest that would be subordinate to the rights of such a
lien creditor. Under revised Article 9, as under prior law, this means that the
trustee can avoid a security interest that has not yet been perfected as of the
petition date.<a href="#3" name="3a">3</a> Since most security interests are perfected by filing a financing
statement, the standards for measuring compliance with the filing requirements will be
critical in determining whether a security interest can be avoided.

Revised Article 9 greatly reduces the probability of making fatal financing statement
errors both by reducing the number of filings required<a href="#4" name="4a">4</a> and by reducing the types of
errors that can render the financing statement ineffective.<a href="#5" name="5a">5</a> With respect to the
contents of the financing statement, only errors in the debtor's name, secured party's
name or indication of the collateral can render the financing statement ineffective as
to lien creditors—and thus trustees—in bankruptcy.<a href="#6" name="6a">6</a>

Of these three items, only the debtor's name is likely to provide much opportunity
for lien avoidance. Since revised Article 9 greatly relaxes the collateral indication
requirement and even permits "all assets" filings, it will become much more difficult
for trustees to avoid security interests on the basis of collateral description
errors.<a href="#7" name="7a">7</a>

The trustee's ability to avoid security interests on the basis of financing statement
errors is further reduced by §9-506(a). Under that section, an error does not
render the security interest unperfected unless the error "make[s] the financing statement
seriously misleading."<a href="#8" name="8a">8</a> Official Comment 2 interprets this standard to remove errors
involving the secured party's name from the list of potentially fatal errors. As
stated in the comment, "Inasmuch as searches are not conducted under the secured
party's name...an error in the name of the secured party or its representative will
not be seriously misleading."<a href="#9" name="9a">9</a> Thus, the principal focus of strong-arm challenges to
financing statements will be the debtor's name requirement.

<h3>The Correct Name</h3>

In general, revised Article 9 provides clearer rules for determining the correct
name to use for a debtor on a financing statement. For registered organizations such
as corporations, limited partnerships and limited-liability companies, the financing
statement must list the name of the debtor as it appears in the public records of
the jurisdiction where the debtor was organized (i.e., the incorporation records of
the state of incorporation).<a href="#10" name="10a">10</a> For human debtors and most unregistered organizations,
the financing statement must list the "individual or organizational name" of the
debtor.<a href="#11" name="11a">11</a>

While these rules make it very easy to determine the correct name for registered
organizations, revised Article 9 makes no attempt to resolve the many issues that
can arise with respect to human names. For example, the revision does not indicate
whether the full legal name is required or whether a nickname or widely used alias
is sufficient. While the old manual search systems could accommodate some variation in
human names, the modern computerized search logic used by the filing offices has little
tolerance for variations. Thus, courts interpreting the revision will be forced to
resolve these issues in light of the limitations of computerized filing systems.

<h3>The "Seriously Misleading" Standard</h3>

As noted above, an error in the debtor's name is not fatal unless it makes the
financing statement seriously misleading. Under prior law, the courts determined whether
an error was seriously misleading by asking whether a hypothetical "reasonably diligent
searcher" could discover the erroneous filing. Under this standard, human judgment was
relevant, and being close was often good enough. For name errors, the revision
replaces this reasonableness standard with a precise standard based on the computerized
search logic used by the relevant filing office. Under the new standard, a name error
is fatal if a search under the correct name, using the filing office's standard search
logic, would not disclose the financing statement.<a href="#12" name="12a">12</a> Thus, the focus will be on
the degree of tolerance built into the relevant office's search logic.

The search logic standards are still evolving at this early stage of the revision
process and some states may adopt unique standards. However, the International
Association of Corporation Administrators has promulgated a set of Model
Administrative Rules for revised Article 9 that has already been adopted by several
states. These rules appear at <a href="http://www.iaca.org/sts/" target="window2">http://www.iaca.org/sts/</a> and, as of early September, had
been adopted in whole or part in Iowa, Minnesota, New Mexico, Virginia and
Washington. These rules illustrate how small a margin for error may be provided by
the new search logic-based test for seriously misleading errors.

Since a computerized search system generates results by applying standardized search
logic to the name presented to the filing officer, human judgment does not play any
role in determining the results of the search.<a href="#13" name="13a">13</a> Instead, the search logic rules
convert both the name to be searched and the names in the index into a standardized
format. Then the computer generates a search result based on exact matches between the
search criteria and the database of filings. The search logic could be either very
liberal or very strict. For example, an extremely liberal approach might be to
convert the name "Libby Corp." into simply "L" and to similarly convert all other
names beginning with an "L" into simply "L." This approach would be very forgiving
of errors, but since the search result would include all "L" debtors, it would be
uselessly overbroad. At the other extreme, the system could be very strict and
produce only filings with "Libby Corp.," and not "The Libby Corp." or "Libby
Corporation" or "LibbyCorp."

Although the search logic proposed in the Model Rules leans toward the strict end
of the spectrum, it does include several features that may save an otherwise
incorrectly listed debtor's name. First, the search logic ignores punctuation,
accents, capitalization and spaces.<a href="#14" name="14a">14</a> Thus, if the financing statement contains these
types of errors in the debtor's name, the errors will not render the statement
ineffective. In addition, certain "noise words" also are ignored. Thus, the word
"the" at the beginning of the name is disregarded.<a href="#15" name="15a">15</a> Further, most words or
abbreviations indicating the nature of the organization at the end of the name are
ignored.<a href="#16" name="16a">16</a> For example, endings such as "Corp.," "Co.," "Ltd.," "Credit
Union" and "Attorneys at Law" are not considered.<a href="#17" name="17a">17</a>

Thus, for example, if the debtor's correct name is "The BigDebtor's Store
Inc.," the filing system would see the name as "bigdebtorsstore." If a secured
creditor incorrectly listed the debtor's name as "Big Debtors Store Attorneys at
Law," the system would see that as "bigdebtorsstore" and the error would not be
seriously misleading.

On the other hand, once the names have been modified by the search logic, the
search will produce financing statements only if the names "exactly match."<a href="#18" name="18a">18</a> Thus,
even a minor misspelling or a typographical error in one of the critical characters
will be fatal. For example, under the prior law, the failure to include the final
"e" in the word "store" (i.e., listing the debtor's name as "The BigDebtor's Stor
Inc.") probably would not have rendered the filing ineffective under the "reasonably
diligent searcher" test. However, under the Model Rules, such an error would render
the security interest unperfected and susceptible to a "strong-arm" attack by the
bankruptcy trustee.

Human names present special difficulties. One must first determine the "correct"
name of the debtor. As noted earlier, the revision gives clear rules for registered
entities, but no rules for determining the correct names of individuals. The Model
Rules do provide some flexibility that will allow names short of full legal names to
be effective. First, with respect to an individual's first or middle names, initials
are treated as the equivalent of all names that begin with that initial.<a href="#19" name="19a">19</a> Further,
if no middle name or initial is listed, that is treated as the equivalent of all
middle names or initials.<a href="#20" name="20a">20</a>

Assume that the debtor's full legal name is "Robert John Smith." If the financing
statement incorrectly lists the name as only "Robert Smith," the filing system would
see the name as "Robert (any middle name) Smith." Since a search under the correct
full legal name would discover the filing, the error would not be fatal. Similarly,
a filing under "R. Smith" would be effective because the system would treat the "R"
as equal to "Robert," and all other names starting with an "R." For the same reason
a filing under "Robert J. Smith" would also be effective. However, a filing under
only the middle and last names (i.e., "John Smith"), with no entry in the "First
Name" field, would not be effective because the "no middle name equals all middle
names" rule applies only to entries in the "Middle Name" field.

Once the names have been modified by the search logic, the search will produce
financing statements only if the names "exactly match." No further flexibility is
provided by the search logic. For example, the search logic does not treat common
variations of first names or common misspellings or variations of last names as
equivalent to the correct name. Thus, for example, a filing under "Rob Smith" or
"Robert John Smythe" will not be discovered by a search under the debtor's full legal
name.<a href="#21" name="21a">21</a> Such an error would be seriously misleading and would render the security
interest susceptible to a "strong-arm" attack by the bankruptcy trustee. Similarly, a
filing with an incorrect middle initial (e.g., "Robert P. Smith") would be
ineffective.

Does the trustee automatically win if the financing statement lists only "Rob
Smith"? Not necessarily. The secured creditor could argue that "Rob Smith" is a
"correct" name for the debtor. Revised Article 9 does not tell us whether that
argument prevails.

<hr>
<h3>Footnotes</h3>

<a name="1">1</a> The views expressed herein are Prof. Warner's and do not necessarily reflect the views of the University of Missouri or the law
firm of Greenberg Traurig P.C. <a href="#1a">Return to article</a>

<a name="2">2</a> See <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… U.S.C. §544(a)(1)</a>. <a href="#2a">Return to article</a>

<a name="3">3</a> See 9-317(a)(2). (All citations are to the revised 1999 version of Article 9 of the Uniform Commercial Code,
unless otherwise indicated. Citations to the prior version of Article 9 are indicated by the term "former.") An exception to this rule
provides a 20-day grace period for filing a financing statement for a purchase money security interest. See §9-317(e). <a href="#3a">Return to article</a>

<a name="4">4</a> Generally, only a single filing in the debtor's state of location is required. See <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…, G. Ray, "Secured Transactions: New
Filing Rules Follow the Debtor," 19 Am. Bankr. Inst. J. 16 (March 2000)</a>. <a href="#4a">Return to article</a>

<a name="5">5</a> See, generally, <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…, G. Ray, "Secured Transactions: Documenting a Transaction Under Revised Article 9," 19 Am. Bankr.
Inst. J. 20 (April 2000)</a>. <a href="#5a">Return to article</a>

<a name="6">6</a> See §9-502(a). Although revised Article 9 does require additional information in the financing statement (see

§9-516(b)(5)), only competing secured creditors and other purchasers can take advantage of errors involving those additional items. See
§9-338. <a href="#6a">Return to article</a>

<a name="7">7</a> See §9-504. <a href="#7a">Return to article</a>

<a name="8">8</a> §9-506(a). <a href="#8a">Return to article</a>

<a name="9">9</a> §9-506, cmt. 2 (emphasis added). <a href="#9a">Return to article</a>

<a name="10">10</a> §9-503(a)(1). The debtor's trade names are neither sufficient nor required. §9-503(b) and (c). <a href="#10a">Return to article</a>

<a name="11">11</a> §9-503(4). Special rules apply to decedent estates, trusts and debtors that have no name. See §9-503(a)(2), (3)
and (4). <a href="#11a">Return to article</a>

<a name="12">12</a> §9-506(c); see, also, §9-506(b). <a href="#12a">Return to article</a>

<a name="13">13</a> Model Rules, §503. <a href="#13a">Return to article</a>

<a name="14">14</a> Model Rules, §§503.2, 503.3 and 503.6. <a href="#14a">Return to article</a>

<a name="15">15</a> Model Rules, §503.5. <a href="#15a">Return to article</a>

<a name="16">16</a> Model Rules, §503.4. <a href="#16a">Return to article</a>

<a name="17">17</a> The IACA list of almost 70 ending-noise words appears at <a href="http://www.iaca.org/sts/bus_ending.pdf" target="window2">http://www.iaca.org/sts/bus_ending.pdf</a>. Note that only ending-noise words
are ignored. Thus, for example, the system would not ignore the word "Corp" in the name "Warner Corp Financial Inc." <a href="#17a">Return to article</a>

<a name="18">18</a> Model Rules, §503.8. <a href="#18a">Return to article</a>

<a name="19">19</a> Model Rules, §503.7. <a href="#19a">Return to article</a>

<a name="20">20</a> <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…; <a href="#20a">Return to article</a>

<a name="21">21</a> Since some states may adopt rules that do treat common variations as equivalents, it will be important to review the rules in the
relevant state. <a href="#21a">Return to article</a>

Journal Authors

G. Ray Warner

Journal Date

Monday, October 1, 2001 - 12:00

Bankruptcy Rule

2001