Preferences and the Use of Revised Article 9 to Correct Perfection Defects

Journal Issue

Sep 2001

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Although the rules governing the transition from the prior version of Article 9 to
revised Article 9 present a number of challenges to secured creditors wishing to
maintain the perfected status of an old-act transaction, the rules also present an
opportunity to correct defects in perfection that might otherwise lead to the avoidance
of the security interest in a bankruptcy proceeding. Several of the transition rules
under revised Article 9 correct old-act perfection defects without requiring any
affirmative action by the secured creditor. In other instances, the revised act
permits the secured creditor to take steps necessary to correct perfection defects without
the consent or assistance of the debtor. While the ability to remedy perfection defects
during the transition will be beneficial to secured creditors, the trustee in bankruptcy
will be able to avoid any late-perfected security interest if the bankruptcy petition
is filed within the relevant 90-day or one-year preference look-back period following
perfection.

<h3>The Strong-arm Power and Unperfected Security Interests</h3>

Under §544(a)(1) of the Bankruptcy Code, the trustee in bankruptcy is given
the powers of, and may avoid a transfer voidable by, a judicial lien creditor that
obtained a judicial lien on the date of bankruptcy.<a href="#2" name="2a">2</a> This "hypothetical lien creditor
power" gives the estate 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 former Article 9, this
meant that the trustee could avoid a security interest that was not yet perfected as
of the petition date.<a href="#3" name="3a">3</a> Revised Article 9 carries this rule forward with a minor
modification that establishes the security interest's priority as of the date the
financing statement is filed, even if it is not yet technically "perfected."<a href="#4" name="4a">4</a> As
a result of these Article 9 rules, the failure to file an effective financing
statement in the proper filing office(s) can result in the security interest being
avoided.

<h3>Automatically Corrected Defects</h3>

Under revised Article 9, a pre-effective date financing statement that is proper
under former Article 9 will remain fully effective after the July 1, 2001,
revised Article 9 effective date for its normal five-year lifespan, or until June
30, 2006, whichever is earlier.<a href="#5" name="5a">5</a> Thus, effective old-act financing statements
will continue to perfect security interests during the transition period, even if the
old-act financing statement would not satisfy the requirements of revised Article 9.<a href="#6" name="6a">6</a>

In addition, the transition rules give full effect to a financing statement that
satisfies the requirements of revised Article 9, even if it did not satisfy the
requirements of former Article 9.<a href="#7" name="7a">7</a> The obvious purpose of this provision was to
permit a secured creditor to file revised-act financing statements prior to the July
1 effective date. Such financing statements would not become effective until the
revision's July 1 effective date.<a href="#8" name="8a">8</a>

However, the rule is not limited to premature revised-act financing statements,
but instead extends its protection to any financing statement that satisfies the
requirements of revised Article 9, regardless of the reason why the financing
statement was filed.<a href="#9" name="9a">9</a> Since many of the filing rules under revised Article 9 are
different from those under former Article 9, and several are more liberal, this rule
has the effect of automatically converting some defective old-act financing statements
into effective revised-act financing statements at the stroke of midnight on June 30,
2001. In such cases, the unperfected old-act security interest becomes perfected,
and the §544 strong-arm power can no longer be used to avoid it.

There are a variety of situations in which the revision will automatically perfect
a previously unperfected security interest. One major area where this will occur is
in the new place of filing rules under the revision. As discussed in an earlier
column, revised Article 9 generally requires that the financing statement be filed
only in the state where the debtor is located, rather than the state(s) where the
collateral is located.<a href="#10" name="10a">10</a> If an old-act financing statement covering inventory in
several states was erroneously filed only in the state of the debtor's location, then
on June 30, 2001, the security interest would have been perfected only as to
inventory located in that state. However, as a result of the operation of
§9-705(b), on July 1, 2001, the security interest became perfected as to
inventory located in all states. In addition, although the former law often required
filing at the county level and sometimes required dual filing in both the county and
secretary of state's office, the revised act generally requires only a single filing
in a statewide office. In such a case, an old-act financing statement filed
erroneously in only the secretary of state's office would be ineffective prior to July
1, but would become effective as soon as the revised act became effective.

Automatic perfection can also result from the relaxation of the requirements for a
valid financing statement under revised Article 9. For example, the failure to
include the debtor's address might render an old-act financing statement ineffective,
but would not affect the validity of a financing statement under revised Article
9.<a href="#11" name="11a">11</a> Thus, on July 1, such a defective financing statement would become fully
effective. Similarly, the new collateral description standards could remedy a variety
of description errors in old-act financing statements. First, an old-act financing
statement that listed "all assets" or "instruments" would become effective. In
addition, since the revised act expands the "accounts" category to include a variety
of payment rights like license fees, franchise fees, etc., an old-act financing
statement that lists "accounts" would begin to perfect a security interest in those
assets on July 1. Finally, since the description standards have been relaxed to
permit such things a description by computational formula, some descriptions that may
have been deficient under former law may be sufficient under revised Article 9.<a href="#12" name="12a">12</a>

<h3>Using Revised Article 9 to Correct Perfection Defects</h3>

In addition to automatically perfecting some previously unperfected security interests,
revised Article 9 makes it much easier for the secured creditor to file or amend
a financing statement in order to correct any perfection defects. Under the former
law, it was also possible to correct financing statement defects; however, the
requirement that the debtor sign the financing statement or amendment meant that the
debtor's cooperation was needed.<a href="#13" name="13a">13</a> Revised Article 9 dispenses with the signature
requirement, making it possible for the secured creditor to file or amend a financing
statement without the debtor's cooperation, knowledge or consent.

Two different provisions of revised Article 9 yield this result. First, as a
general principle, the revised act treats the debtor's authentication of the security
agreement as authorization to file a financing statement or an amendment covering the
collateral described in the security agreement.<a href="#14" name="14a">14</a> Thus, after the act's effective
date, the secured creditor is authorized to file or amend its financing statements as
necessary to perfect its security interest in the collateral described in the underlying
security agreement without obtaining the debtor's signature or a separate authorization.
In addition, the transition rules provide broad authority to file initial financing
statements or continuation statements as necessary "to perfect or continue the perfection
of a security interest."<a href="#15" name="15a">15</a> As explained in the comment to that section, "[T]his
section does not require authorization from the debtor."<a href="#16" name="16a">16</a>

Since the revision will cause most secured creditors to review existing loans in
order to convert their filings to the new appropriate revised act filing offices, it
provides an excellent opportunity to undertake a loan review and correct any perfection
problems as part of that conversion process. There are different methods of amending
a previous old-act financing statement depending on whether the old-act filing is
located in the same office that would be proper under the revised act.

In many cases, the proper filing office under the revised act will be the same
office where the old-act financing statement is already on file. In such a case,
all that is necessary to do is file an amendment under revised Article 9. No
separate authorization or signature of the debtor is required as long as the amendment
covers collateral described in the security agreement. Separate authorization from the
debtor will be necessary if the secured creditor wishes to use broader language in the
financing statement, such as "all assets."

If, however, the revised act's filing rules specify a filing office different from
the one in which the old-act financing statement is on file, a different procedure
must be used. After the effective date of revised Article 9, an amendment filed
in the old-act office will not be effective.<a href="#17" name="17a">17</a> Instead, the secured creditor must
file a new initial financing statement in lieu of a continuation statement
(IFSILOACS) in the new appropriate state in order to convert its old-act
financing statement into a revised-act financing statement.<a href="#18" name="18a">18</a> The amendment could be
made in either of two ways.<a href="#19" name="19a">19</a> First, the IFSILOACS could simply include the
new information, such as a broader collateral description. Alternatively, the
IFSILOACS could be filed first, and then subsequently amended by filing a separate
amendment.

<h3>Using the Preference Power to Attack Late Perfection</h3>

In order for the secured creditor to benefit from the above-described strategies
to remedy perfection defects, the debtor must remain out of bankruptcy for the relevant
preference look-back period after the security interest becomes perfected. This is
because of a special preference rule that treats the perfection date as the date of
transfer for security interests that are perfected more than 10 days after the
attachment of the security interest.<a href="#20" name="20a">20</a> Thus, even though the security interest may
have been created long before the preference period, the trustee will be able to avoid
it if it was perfected during the preference period.<a href="#21" name="21a">21</a>

In the case of security interests that automatically become perfected merely because
of changes in revised Article 9, the security interest will be deemed to have been
transferred on the act's July 1 effective date. For security interests that are
perfected by filing a post-revision financing statement or amendment, the security
interest will be deemed to have been transferred on the date the amendment or financing
statement is filed. For security interests granted to non-insider creditors, this will
generally mean that the security interest can be avoided if the debtor files bankruptcy
within 90 days after perfection has been achieved.<a href="#22" name="22a">22</a> However, if the creditor
qualifies as an insider, then the security interest can be avoided if the debtor files
bankruptcy within one year after perfection has been achieved.<a href="#23" name="23a">23</a>

Ironically, the one-year look-back period may also apply to a non-insider secured
creditor if the loan is guaranteed by an insider. This is a variation of the
Deprizio problem,<a href="#24" name="24a">24</a> part of which was solved by §550(c), which prevents the
trustee from seeking an affirmative monetary recovery from a non-insider who receives
payment on an insider-guaranteed debt.<a href="#25" name="25a">25</a> However, since the Code distinguishes
between the avoidance of a transfer under §547(b) and the recovery from the
transferee of such a transfer under §550, the §550(c) provision does not protect
the non-insider when the only relief sought is the avoidance of the transfer.<a href="#26" name="26a">26</a> In
the case of a late-perfected security interest, the avoidance of the lien and its
automatic preservation for the estate under §551 is all the relief that the trustee
would require. Thus, a one-year look-back period would apply to late-perfected
security interests in cases where the debt is guaranteed by an insider.

<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 former §9-301(1)(b). [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
applied to purchase-money security interests, which were given a grace period to file the financing statement. See former §9-301(2). <a href="#3a">Return to article</a>

<a name="4">4</a> See 9-317(a)(2). In addition, revised Article 9 provides a 20-day grace period for filing a financing statement for
a purchase-money security interest. See §9-317(e). <a href="#4a">Return to article</a>

<a name="5">5</a> See §9-705(c). Note that Alabama, Connecticut, Florida and Mississippi have delayed effective dates. See Warner, G. Ray,
"Non-uniform Effective Dates and the Transition to Revised Article 9," 20 Am. Bankr. Inst. J. (July/August 2001). However,
only Alabama has extended the June 30 "drop-dead" date to Dec. 31, 2006. The impact of these non-uniform effective dates will
be ignored for the purposes of the analysis in this column. <a href="#5a">Return to article</a>

<a name="6">6</a> See, generally, <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…, G. Ray, "Surviving the Transition to Revised Article 9: The Basics," 20 Am. Bankr. Inst.
J. 18 (May 2001)</a>. <a href="#6a">Return to article</a>

<a name="7">7</a> See §9-705(b). <a href="#7a">Return to article</a>

<a name="8">8</a> See §9-701. <a href="#8a">Return to article</a>

<a name="9">9</a> See 9-705, cmt. 3. <a href="#9a">Return to article</a>

<a name="10">10</a> See <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…, G. Ray, "New Filing Rules Follow the Debtor," 19 Am. Bankr. Inst. J. 16 (March 2000)</a>. <a href="#10a">Return to article</a>

<a name="11">11</a> Compare former §9-402(1) with §9-502(a). <a href="#11a">Return to article</a>

<a name="12">12</a> See §9-108(b). <a href="#12a">Return to article</a>

<a name="13">13</a> See former §9-402(1) and (4). <a href="#13a">Return to article</a>

<a name="14">14</a> See §9-509(b). <a href="#14a">Return to article</a>

<a name="15">15</a> See §9-708(2)(B). <a href="#15a">Return to article</a>

<a name="16">16</a> See §9-708, cmt. <a href="#16a">Return to article</a>

<a name="17">17</a> See §9-707(b) and cmt. 3. <a href="#17a">Return to article</a>

<a name="18">18</a> For an explanation of these procedures, see <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…, G. Ray, "Surviving the Transition to Revised Article 9: Maintaining
Perfection," 20 Am. Bankr. Inst. J. 22 (June 2001)</a>. <a href="#18a">Return to article</a>

<a name="19">19</a> These options are set forth in §9-707(c)(2) and (3). A third option, filing the IFSILOACS and amendment
concurrently, is authorized by that section, but presents practical difficulties that should make that option unavailable. See <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…, Harry
C., and Smith, Edwin E., "Revised U.C.C. Article 9's Transition Rules: Insuring a Soft Landing (Part II)," 55 Bus. Law.
1763, 1773, n. 39 (2000)</a>. <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=… U.S.C. §547(e)(2)(a)</a> and (b). <a href="#20a">Return to article</a>

<a name="21">21</a> See <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… Financial Services Inc. v. Fink, 522 U.S. 211, 118 S.Ct. 651 (1998)</a>. <a href="#21a">Return to article</a>

<a name="22">22</a> See <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… U.S.C. §547(b)(4)(A)</a> (setting 90-day look-back period for non-insiders). <a href="#22a">Return to article</a>

<a name="23">23</a> See <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… U.S.C. §547(b)(4)(B)</a> (setting a one-year look-back period for insiders). <a href="#23a">Return to article</a>

<a name="24">24</a> See <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re V.N. Deprizio Construction Co., 874 F.2d 1186 (7th Cir. 1989)</a>. Under Deprizio, the transfer
would be for the benefit of the insider, and the insider's rights of reimbursement or contribution would make it a creditor, unless those
rights were waived. <a href="#24a">Return to article</a>

<a name="25">25</a> See <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… U.S.C. §550(c)</a>. <a href="#25a">Return to article</a>

<a name="26">26</a> <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Williams, 234 B.R. 801, 804-05 (Bankr. D. Ore. 1999)</a>. <a href="#26a">Return to article</a>

Journal Authors

G. Ray Warner

Journal Date

Saturday, September 1, 2001 - 12:00

Bankruptcy Rule

2001