New Filing Rules Follow the Debtor

Although revised Article 9 will introduce numerous changes, the new rules for perfecting security
interests bear many similarities to current law. The filing of a financing statement will continue to be the
primary method of perfecting security interests. However, the new filing rules also contain a number of
subtle, but important, differences from current law.

</p><p>For many transactions, especially those involving tangible and quasi-tangible items of collateral,
revised Article 9 will change both the state and the places within a state where financing statements must
be filed. In general, these changes will make it much easier for a secured creditor to perfect its security
interest, especially in transactions involving debtors with multi-state operations.

</p><p>However, these revisions also carry a downside for secured creditors and their attorneys. No longer can
counsel expect to be able to document and perfect a local transaction under the local state's law. Instead,
even if the tangible asset that serves as collateral is located in a particular state, it may be necessary to
obtain local counsel in a different state, or even a foreign country, to ensure that the security interest is
perfected properly. Further, by concentrating all filings for a particular debtor in a single state's records,
these rules may result in Uniform Commercial Code (UCC) searches that produce an overwhelming
number of filings that must be investigated in order to determine whether the collateral is subject to a prior
perfected security interest.

</p><h3>New Types of Collateral and Liens</h3>

<p>The revised act expands the types of collateral and liens that can be perfected by filing a financing
statement. First, the revision extends the scope of Article 9 to reach additional types of property and new
types of liens. For example, consensual liens on commercial tort claims and health care receivables are
now within the scope of Article 9 and can be perfected by filing. <i>See</i> §§9-109(d)(8 &amp; 12); 9-310(a)
(unless otherwise noted, all citations are to revised Article 9). In addition, Article 9 now covers one type
of non-consensual statutory lien—"agricultural liens"—and provides for their perfection through the filing
of a financing statement. <i>See</i> §§9-109(a)(2) and 9-310(a).

</p><p>Further, unlike prior law, a security interest in instruments (<i>e.g.,</i> promissory notes) can be perfected by
filing a financing statement. <i>See</i> §9-312(a). However, the "perfection" achieved by such a filing is not
as complete as perfection by possession of the instrument. While filing will not give the secured creditor
protection against purchasers and competing security interests that are perfected by possession, it will
priority over a latter secured creditor who perfects by filing and over a lien creditor. Compare
§§9-317(a)(2) and 9-322(a)(1) with §9-330(d). As a result, since the bankruptcy trustee's power to avoid
security interests under the §544(a) "strong arm" power is based on the rights of a hypothetical lien
creditor, the filing of a financing statement covering instruments will protect the security interest from
avoidance in a subsequent bankruptcy of the debtor. This is similar to the treatment of security interests
in investment property (<i>e.g.,</i> securities) under current law, which is continued under revised Article 9. <i>See</i> §9-328.

</p><h3>Local Filing Eliminated</h3>

<p>One significant change in the rules governing the place of filing is the elimination of the need to file
a financing statement in a local (county) office for collateral that is not related to real estate. <i>See</i>
§9-501(a)(2). Under current law, many states require county-based filing for consumer goods,
farm-related collateral and collateral owned by a strictly local business. In addition, in some cases it is
necessary to file both in a county office and with the Secretary of State, or, in the case of crops, in the
farmer's county of residence and the county where the crops are growing. Under revised Article 9, the
local filing requirement is eliminated for these types of collateral. Instead, most financing statements
will be filed in a single state-wide office, such as the Secretary of State's office. Special rules apply if
the debtor is a transmitting utility. <i>See</i> §9-501.

</p><p>The primary exceptions to this rule are fixture filings and financing statements covering "as extracted"
collateral and "timber to be cut." In these cases, the financing statement must be filed in the office where
a mortgage on the related real estate would be filed. <i>See</i> §9-501(a)(1). "As extracted" collateral covers
oil, gas and minerals if the security interest attaches upon extraction, and also covers accounts arising out
of their sale at the wellhead or minehead.

</p><p><i>See</i> §9-102(a)(6). The analysis for timber is more complex and holds a trap for the unwary. During the
time that the timber is standing, the financing statement must be filed in the local real estate records.
However, once the timber is cut, it becomes ordinary goods and must be perfected by a filing in the
appropriate state-wide office. That office may even be in a different state, depending on the location of
the debtor.

</p><h3>The Proper State for Filing</h3>

<p>The more significant change is in the choice of law rules that determine the proper jurisdiction in
which to file a financing statement. Current law generally looks to the location of the debtor for
intangible collateral (<i>e.g.,</i> accounts and general intangibles), but looks to the location of the collateral for
tangible collateral (<i>e.g.,</i> ordinary goods) and quasi-tangible collateral (<i>e.g.,</i> instruments). Revised Article
9 rejects the "location of the collateral" test and adopts the location of the debtor as the proper jurisdiction
for filing financing statements for both tangible and intangible collateral. <i>See</i> §9-301(1). Note that this
difference between the current law and revised Article 9 will create significant problems if any states fail
to adopt the revision by its effective date. Failure to file under both rules could result in a loss of
perfection, depending on the state in which the litigation challenging perfection is brought.

</p><p>Thus, virtually all financing statements relating to a particular debtor will be filed in the same office,
regardless of the type of collateral involved or its location. This change will make it much cheaper and
simpler to perfect security interests in the assets of multi-state business operations. For example, if a
lender wishes to perfect a security interest in all of the inventory and accounts of a debtor with store
locations in multiple states, it can do so by filing a single financing statement in the state where the
debtor is located. Under prior law, the lender would have been required to file its "accounts" financing
statement in the state where the debtor's chief executive office was located, and file "inventory" financing
statements in each state where a store was located.

</p><p>Note that while revised Article 9 changes the choice of law rules for perfection by filing for
tangible and quasi-tangible items of collateral, it does not change the choice of law rules for
determining the effect of perfection and priority. <i>See</i> §9-301(3)(C). For example, if the debtor is
located in Delaware, but the collateral is equipment that is located in Alaska, the financing statement
must be filed in Delaware and must comply with the Delaware version of Article 9 in order to perfect
the security interest. However, since the collateral is located in Alaska, the Alaska version of Article
9 will determine the effect of the Delaware filing, and Alaska law will determine the relative priority
of competing claimants in the collateral.

</p><p>Although most financing statements must be filed in the jurisdiction where the debtor is located, this
rule does not apply to real estate-related collateral. Fixture filings and filings for "as extracted" collateral
and timber to be cut must be filed in the state where the related real estate is located. <i>See</i> §§9-301(3)(A
&amp; B) and 9-301(4).

</p><p>Another major exception is agricultural liens. In order to perfect a statutory agricultural lien, the
financing statement must be filed in the jurisdiction where the farm products are located. <i>See</i> §9-302.
Thus, farm products lenders may have to be concerned about multiple filing locations. Financing
statements for security interests must be filed in the UCC records of the state where the debtor is located,
financing statements for agricultural liens in the same farm products must be filed in the UCC records
of the state where the farm products are located, and an "effective financing statement" may have to be
filed in the Food Security Act system to protect the lien against buyers of those farm products. <i>See</i> <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&amp;vr=1.0&amp;cite=…
U.S.C. §1631</a>.

</p><p>Finally, the above rules apply only where perfection is accomplished by filing a financing statement.
Thus, the "location of the debtor" rule does not apply where the security interest is perfected by
possession, or where the collateral is covered by a certificate of title (<i>e.g.,</i> automobiles that are not held
as inventory). See §§9-301(2) and 9-303.

</p><h3>Location of the Debtor</h3>

<p>Along with its increased emphasis on the location of the debtor, revised Article 9 partially clarifies
the rules for determining the debtor's location. The current location rules for individuals are carried
forward. Thus, an individual is located at his/her principal residence, and financing statements must be
filed in that jurisdiction in order to perfect most security interests. <i>See</i> §9-307(b)(1).

</p><p>However, the rule for organizations has been changed dramatically. If the organization is a registered
organization that is organized under the laws of a U.S. state, territory, Puerto Rico or the District of
Columbia, then its location is deemed to be in that state. <i>See</i> §9-307(e). Thus, a Delaware corporation
is deemed to be located in Delaware, even if it has no operations or assets located in that state. The new
rule has the benefit of easy application, since it will be relatively simple to determine the proper state in
which to file. While this will benefit national lenders, it may impose increased costs and risks on local
lenders. For example, if the debtor is incorporated in a distant state, even a purely local transaction will
have to be perfected under that distant state's law, and that may require the assistance of counsel in the
distant state. Since many corporations are incorporated in Delaware, that state likely will become the
center of the corporate secured transactions universe, just as it has become the center of the corporate
bankruptcy universe.

</p><p>For organizations that are not registered organizations, the new location rules are virtually identical
to current law. If the organization has only one place of business, then that is its location. Otherwise it
is located at its chief executive office. <i>See</i> §9-307(b)(2 and 3). Special rules apply to foreign banks,
foreign air carriers and organizations registered under federal law. <i>See</i> §9-307(f, h, i and j).

</p><p>The new filing rules reflect a trend toward globalization and produce some surprising, but intended,
results in international transactions. Since the registered organization rules do not apply to organizations
registered under foreign law, the location of such a debtor would be its chief executive office. Thus, even
if the collateral owned by a foreign company is inventory located in New York, it may be necessary for a
lender to perfect in a foreign country under foreign law. The same would be true for an individual debtor
(U.S. citizen or otherwise) whose principal residence was located in a foreign country. This result applies,
however, only if the foreign jurisdiction generally requires public recordation as a condition or result of the
security interest's obtaining priority over the rights of a lien creditor. If the relevant foreign jurisdiction does
not have such a system, then the debtor is deemed to be located in the District of Columbia. <i>See</i> §9-307(c).
Thus, the nature of the foreign country's law determines whether the filing must be in the District of
Columbia or in the foreign country.

</p><h3>Enactment Update</h3>

<p>Since last month's column, nine new states have introduced legislation to adopt revised Article 9, for
a total of 20 states. The number of states enacting the revision remains steady at seven.

</p>