Surviving the Transition to Revised Article 9 The Basics

Journal Issue

May 2001

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The July 1, 2001, effective date of revised Article 9 is just around the
corner. The changeover to a new legal regime is never an easy process; the Article
9 transition will be no exception. As discussed in previous columns, the revision
changes many of the rules that govern the creation, perfection and enforcement of
security interests in personal property. How will those changes affect secured
transactions entered into before the revision's effective date?

Revised Article 9 attempts to answer this question in a mind-numbing series of
transition rules. See §§9-701-9-709.<a href="#2" name="2a">2</a> These rules assume that all states will
have adopted the revision prior to its effective date, and thus all states will
switch over to the new regime simultaneously on July 1.<a href="#3" name="3a">3</a> The transition would be
difficult enough if that occurred. Unfortunately, it appears that a substantial minority
of states will not meet the target date. The revised act makes no attempt to explain
what will happen if one or more states fail to adopt the revision on time,<a href="#4" name="4a">4</a> and
I am not brave or foolish enough to attempt that feat here—at least not yet. So
let's just pretend that every state adopts the revision, and let's see how the
transition is supposed to work. As you'll see, even with that simplifying assumption,
there is only enough room in one column to discuss the most basic rules.

<h3>The Easy Stuff</h3>

This month's column will deal with the effects of the revision on an existing security
interest that was taken under current Article 9 in an asset that was in existence
prior to the effective date of the revision. Next month, we will look at how the
rules work in more complicated situations and how to continue pre-revision financing
statements.

If the security interest was properly attached and perfected under current Article 9,
there is little to worry about early on. The steps for attachment (i.e.,
enforceability against the debtor) are similar enough so that most security interests
that properly attached under current law should be properly attached under the revision.

<blockquote><blockquote>
<hr>
<big><center>
One of the revision's major reforms is that it
changes the proper state for filing most
financing statements to the state of the
debtor's location.
</center></big>
<hr>
</blockquote></blockquote>

The principal exceptions involve consumer goods and consumer investment property. Under
the revision, a security agreement description by UCC type alone (e.g., "all
consumer goods" or "all securities accounts") is not sufficient for attachment for these
types of assets in a consumer transaction.<a href="#5" name="5a">5</a> Instead, a more specific description is
required, such as "all TVs" or "Merrill Lynch securities account." If a security
interest under an agreement using the "type" description has attached and is perfected
under current law, it remains enforceable and perfected<a href="#6" name="6a">6</a> for one year following the
effective date of revised Article 9.<a href="#7" name="7a">7</a> If, during that year, the debtor
authenticates a new security agreement with a proper collateral description, the security
interest remains enforceable and perfected after the one-year period. If, on the
other hand, no action is taken during the one-year grace period, the security
interest becomes unenforceable at the end of the year.

An "attachment" problem might also arise if the security agreement uses the Article
9 terminology—such as "accounts"—to describe the collateral because some of the UCC
categories of collateral have been redefined. For example, license fees currently
qualify as "general intangibles," but will be considered "accounts" under the
revision.<a href="#8" name="8a">8</a> If the security agreement refers to "license fees," there will be no
problem because any description that would have been adequate under current Article 9
should be an adequate description under revised Article 9.<a href="#9" name="9a">9</a> However, if the
security agreement refers merely to "general intangibles," will its scope change on July
1? The revision does not answer this question, but instead treats it as one of
contract interpretation. Presumably the courts will conclude that the parties meant to
refer to items defined as "general intangibles" at the time of the execution of the
agreement.<a href="#10" name="10a">10</a> However, careful lawyers will clean up the documentation to avoid this
ambiguity because memories fade and courts several years hence may not get the answer
right.

<h3>Perfection by Possession</h3>

What about perfection? Well, that depends on how the transaction was perfected under
current law. The easiest case is perfection by possession. This method remains
effective as a method of perfection under revised Article 9,<a href="#11" name="11a">11</a> so merely by
maintaining possession (which must be done anyway under current law) the security
interest will remain perfected after July 1.<a href="#12" name="12a">12</a>

The principal exception involves the situation where the collateral is in the possession
of a bailee. Under current law, perfection can be achieved merely by giving notice
of the security interest to the bailee.<a href="#13" name="13a">13</a> However, the revision adds a requirement
that the bailee must authenticate an acknowledgement that it holds the collateral for
the secured party's benefit.<a href="#14" name="14a">14</a> Under the transition rules, a pre-revision security
interest properly perfected by giving notice to the bailee remains perfected for one
year following the effective date.<a href="#15" name="15a">15</a> If the secured party obtains the necessary
authenticated acknowledgement from the bailee during that one-year grace period, then
the security interest remains continuously perfected after the one-year period. If,
on the other hand, no acknowledgement is obtained, then perfection lapses at the end
of the year.

<h3>Perfection by Filing</h3>

One of the revision's major reforms is that it changes the proper state for filing
most financing statements to the state of the debtor's location.<a href="#16" name="16a">16</a> Thus, financing
statements filed under current law may be located in a state that would not be the
proper filing state under the revision. In addition, for some types of collateral,
the revision eliminates the need for local filing at the county level and substitutes
filing in a state-wide office. What is the effect of the revision on proper
pre-revision filings that are located in offices that would not be the proper filing
offices under the revision?

If the security interest was properly perfected by filing under current law, then
nothing needs to be done until the earlier of June 30, 2006, or the date when
the filing would have lapsed under current law.<a href="#17" name="17a">17</a> Since financing statements generally
lapse and must be continued after five years, the June 30, 2006, drop-dead date
would have coincided with the longest possible effective pre-revision financing statement
if all states had converted to the revision simultaneously on July 1, 2001. As
it is, the drop-dead date may spell an earlier-than-usual death for any financing
statement filed after July 1, 2001, in a state that does not adopt the revision
in time.

This provision helps the existing pre-revision secured party because it does not need
to take action to remain perfected for up to five years. However, as a result,
a security interest could be validly perfected either by a financing statement filed
under the revision or by a financing statement filed under the current law for up to
five years following July 1, 2001 (or longer if any late-adopting state modifies
the drop-dead date). This means that a search of the filing system during the first
five years must cover both the old and the new filing locations.

<h3>Priority and Foreclosure</h3>

But what about the new priority rules? Could they affect the lien? Well, maybe.
The current law's priority rules will govern disputes between any parties whose relative
priority was established before the revision's effective date.<a href="#18" name="18a">18</a> Thus, the revision
will have no impact on the relative priority between two secured creditors, both of
whom assert security interests perfected pre-revision.

However, if at least one of the claimants bases its claim of priority on
post-effective date actions, then the revision's priority rules will apply.<a href="#19" name="19a">19</a> In
most cases, this will not create problems for a security interest perfected prior to
the revision's effective date. However, there are a few cases where the problems
could be devastating.

An area where this problem may arise involves proceeds. Under current law, if the
security interest in inventory is perfected, the secured party automatically has a
perfected security interest in any identifiable cash proceeds generated by the sale of
inventory. If those proceeds are deposited into the debtor's bank account, the
"proceeds" security interest will have priority over any set-off rights of the
depository bank (and there will be no competing secured party with a valid security
interest in those funds).

However, under revised Article 9, a competing lender could obtain a security interest
in the deposit account and could perfect by "control."<a href="#20" name="20a">20</a> Since that lien arises and
the perfection step of "control" occurs post-the effective date, the revision's priority
rules will apply to any dispute between the proceeds security interest and the control
security interest—even as to proceeds that came into existence prior to the effective
date. Under the revision, the new control security interest will have priority over a
perfected security interest in proceeds.<a href="#21" name="21a">21</a> In addition, under the revision, the
depository bank's set-off and recoupment rights have priority over a perfected security
interest in proceeds.<a href="#22" name="22a">22</a> Thus, if the bank's set-off or recoupment right arises after
the effective date, the revision's priority rules will apply and will subordinate the
proceeds security interest.

What about the rights and duties of the secured party? Will they change on July 1,
2001? Yes—a repossession or an Article 9 sale occurring on July 2, 2001,
must comply with the new rules, even though the security agreement was entered into
and the default occurred prior to the revision's effective date.<a href="#23" name="23a">23</a> Although there
are some new rules that may not be viewed favorably by the secured creditor (such
as the new notice requirements in consumer cases), most of the changes in the default
and foreclosure rules enhance the secured creditor's rights (e.g., the new partial
strict foreclosure option and the elimination of the absolute bar to deficiencies in
cases of non-compliance with the rules).<a href="#24" name="24a">24</a>

<h3>Enactment Update</h3>

Four new states have adopted revised Article 9 since the last issue. They are
Idaho, Mississippi, New Mexico and Wyoming. Thus, as of early April, only 32
states plus the District of Columbia had adopted revised Article 9. The act has
been introduced in four new states—Florida, Louisiana, Ohio and South Carolina.
Thus, revision bills are pending in 18 states plus the U.S. Virgin Islands.

<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, St. John's
University or the law firm of Greenberg Traurig LLP. <a href="#1a">Return to article</a>

<a name="2">2</a> 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="#2a">Return to article</a>

<a name="3">3</a> Section 9-701 attempts to establish a uniform national effective date of July 1, 2001. <a href="#3a">Return to article</a>

<a name="4"> </a> The Official Comment to §9-701 states, "If former Article 9 is in effect in some jurisdictions, and [revised Article 9]
is in effect in others, horrendous complications may arise." <a href="#4a">Return to article</a>

<a name="5">5</a> See §9-108(e). Note that current law in some states already prohibits the use of a generic "consumer goods" description. <a href="#5a">Return to article</a>

<a name="6">6</a> Perfection could lapse earlier if, for example, the pre-revision financing statement expires during the one-year period. <a href="#6a">Return to article</a>

<a name="7">7</a> See §9-703(b) and cmt. 2. <a href="#7a">Return to article</a>

<a name="8">8</a> Compare current §9-106 with §9-102(a)(2). <a href="#8a">Return to article</a>

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

<a name="10">10</a> See §9-703 cmt. 3. <a href="#10a">Return to article</a>

<a name="11">11</a> See §9-313(a). <a href="#11a">Return to article</a>

<a name="12">12</a> In addition, the relaxed attachment rules continue to apply to possessory security interest, so an oral agreement remains sufficient
to create such a security interest. As a result, the pledgee need do nothing to retain its perfected security interest. <a href="#12a">Return to article</a>

<a name="13">13</a> See current §9-305. <a href="#13a">Return to article</a>

<a name="14">14</a> See §9-313(c) and cmt. 4. <a href="#14a">Return to article</a>

<a name="15">15</a> See §9-703(b) and cmt. 2, ex. 2. <a href="#15a">Return to article</a>

<a name="16">16</a> See, generally, Warner, G. Ray, "Secured Transactions: New Filing Rules Follow the Debtor," 19 ABIJournal 16 (March
2000). <a href="#16a">Return to article</a>

<a name="17">17</a> See §9-705(c). <a href="#17a">Return to article</a>

<a name="18">18</a> See §9-709(a). <a href="#18a">Return to article</a>

<a name="19">19</a> See §9-709 cmt. 1, ex. 3. <a href="#19a">Return to article</a>

<a name="20">20</a> See Warner, G. Ray, "Deposit Accounts as Collateral Under Revised Article 9," 19 ABIJournal 18 (August 2000). <a href="#20a">Return to article</a>

<a name="21">21</a> See §9-327(1) and cmt. 3. <a href="#21a">Return to article</a>

<a name="22">22</a> See §9-340. <a href="#22a">Return to article</a>

<a name="23">23</a> See §9-702(a) and cmt. 1. <a href="#23a">Return to article</a>

<a name="24">24</a> See, generally, Warner, G. Ray, "Default and Foreclosure Under Revised Article 9," 19 ABI Journal 20 (May 2000). <a href="#24a">Return to article</a>

Journal Authors

G. Ray Warner

Journal Date

Tuesday, May 1, 2001 - 12:00

Bankruptcy Rule

2001