Documenting a Transaction under Revised Article 9

For most personal property secured transactions, the two most important documents are the security
agreement and the financing statement. Under current law, a written security agreement signed by the
debtor is necessary in order to create an enforceable security interest in cases where the creditor does not
retain possession of the collateral. <i>See</i> current <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&amp;vr=1.0&amp;cite=… §9-203(1)</a>. In addition, a properly completed <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&amp;vr=1.0&amp;cite=…;

financing statement signed by the debtor must be filed in the proper public offices in order to perfect the
security interest. <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&amp;vr=1.0&amp;cite=… UCC §§9-302</a> and 9-402. Current law sets out a number of content
requirements that these two documents must satisfy in order to be effective. Failure to satisfy these
requirements can result in either a loss of perfection or a loss of secured status.

</p><p>Although revised Article 9 retains the basic framework for the security agreement and financing
statement, it significantly relaxes the minimum standards that these documents must meet. These changes
will make it easier for secured creditors to create and perfect enforceable liens. As a consequence, from a
bankruptcy perspective, these changes will reduce the likelihood that a secured lender will have committed
an error that can be used to avoid its lien under the "strong-arm" power of §544 of the Bankruptcy Code.

</p><h3>Medium Neutrality</h3>

<p>Technological advances and the related move toward paperless business transactions provided a
major impetus for the revision of Article 9. Thus, throughout the revision, the drafters attempted to
make the Code "medium" so that the law would work regardless of whether the parties used paper
documents, computerized records or some future method beyond the contemplation of the drafters.

</p><p>Under the revised Act, neither the security agreement nor the financing statement need be reduced to
a tangible written form. All that is required is a "record," which is a defined term that includes both paper
documents and information "stored in an electronic or other medium" that is "retrievable in perceivable
form." Revised §9-102(69). The storage method need not be permanent or indestructible, and the only clear
limitation is that storage in human memory is not sufficient. Revised §9-102, comment 9(a). While oral
statements standing alone cannot constitute a record, an audio tape recording or an oral message left on a
digital voice messaging system will qualify. <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&amp;vr=1.0&amp;cite=…; Of course, with respect to the financing statement, the filing
office can require use of a particular medium of communication. Revised §9-516(b)(1).

</p><h3>Signatures Unnecessary</h3>

<p>Consistent with the "paperless transaction" theme, the revised Act eliminates the requirement of a
debtor's signature for both the security agreement and financing statement. <i>See</i> revised §§9-203(b)(3)(A), 9-502(a).

</p><p>For the security agreement, the signature requirement has been replaced with a requirement that the
debtor "authenticate" the record of the agreement. Revised §9-203(b)(3)(A). The term "authenticate"
includes all of the currently permissible methods of "signing" a document—a signature, or the execution
or adoption of a symbol. Compare revised §9-102(a)(7) with current §1-201(39). In addition, the
authentication requirement can be satisfied if the debtor "encrypts or similarly processes a record" with
the present intent to identify himself/herself and adopt or accept the record. Revised §9-102(a)(7)(B).

</p><p>While the "authentication" definition is drafted to cover digital signatures, unfortunately neither the
text nor the comments provide any guidance as to what other types of actions will qualify as an
authentication of a non-paper record. For example, in light of the comment's explicit reference to
voice-messaging systems, one would have expected some indication whether such a record could be
authenticated by way of a statement made in the recording (<i>e.g.,</i> "This is John Smith, and I'm leaving
this message to confirm the details of my security agreement..."). Does the use of the term "similar"
require that the processing be similar to encryption or that it be similarly effective in confirming the
identity of the record's author and authenticity of its contents?

</p><p>The revision goes even further with respect to financing statements and entirely eliminates the
requirement of the debtor's signature. <i>See</i> revised §9-502, comment 3. That requirement is replaced with
a requirement that the debtor authorize the filing in an authenticated record. Revised §9-509(a)(1).
Further, the debtor's authentication of the security agreement <i>ipso facto </i>constitutes authorization to file
a financing statement covering the collateral described in the security agreement and proceeds of that
collateral. Revised §9-509(b)(1 &amp; 2). However, if the creditor wishes to file a financing statement worded
more broadly than the security agreement (<i>e.g.,</i> "all assets"), or wishes to file protective financing
statements under the revised Act before its July 1, 2001, effective date, an explicit authenticated
authorization should be obtained from the debtor.

</p><h3>Contents of Security Agreement</h3>

<p>Although parties will wish to include many additional provisions in a well-drafted security agreement,
the minimum requirements for effectiveness are very similar to those under current law. As noted above,
the "writing" and "signature" requirements have been replaced with an "authentication" requirement.
However, like current law, a security agreement must "create or provide for" a security interest. <i>See</i>
revised §§9-102(73), 9-203(b)(3)(A). In addition, like current law, the security agreement must provide
a "description of the collateral." Revised §9-203(b)(3)(A). While current law also requires a land
description for crops growing or to be grown and for timber to be cut, the revision retains that
requirement only for timber to be cut. Compare revised §9-203(b)(3)(A) with current §9-203(1)(a).

</p><p>The revision continues the current law's reasonable identification standard for measuring the
sufficiency of a description, but rejects the more restrictive case law by validating descriptions by
category, UCC type (<i>e.g.,</i> "accounts"), quantity, and by a computational or allocational formula or
procedure. Revised §9-108(b). However, since the revision redefines some of the UCC types, the new
definitions should be reviewed carefully before using a description by UCC type. For example, the
"accounts" definition now includes license fees and some other payment rights that previously were
included in the "general intangible" definition. Compare revised §9-102(2) with current §9-106.

</p><p>A supergeneric description such as "all the debtor's assets" is not a sufficient description for the
purposes of a security agreement. Revised §9-108(c). In addition, in a consumer transaction, a description
only by the UCC types "consumer goods," "security entitlement," "security account" or "commodity
account" is not sufficient. Revised §9-108(e)(2). Finally, since an after-acquired property clause will not
reach a future commercial tort claim (Revised §9-204(b)(2)), commercial tort claims cannot be described
by UCC type (<i>i.e.,</i> "commercial tort claims"). Revised §9-108(e)(1). A general description such as "all tort
claims arising out of the explosion of debtor's plant" would be sufficient. Revised §9-108, comment 5.

</p><h3>Contents of Financing Statement</h3>

<p>The revision's treatment of the financing statement's content requirements is more complex.
Essentially it sets up two classes of "required" information: (1) information that is required in order for
the financing statement to be valid; and (2) information that does not affect validity, but that the filing
office must require as a pre-condition to accepting the statement for filing. The obvious purpose of this
hierarchy is to protect security interests from avoidance in bankruptcy.

</p><p>The only three items of information that must be included in the financing statement in order for it
to be "sufficient" are: (1) the debtor's name; (2) the name of the secured party or its representative; and
(3) an indication of the collateral. Revised §9-502(a).

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If all-assets filings become common, only serious errors in the debtor's name will provide grounds for avoidance under the §544 strong-arm power.
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<p>The revision generally continues the current "name" rules that require use of the individual name for
individuals and the organization's name for an organization that has a name. Revised §9-503(a). For
example, if the debtor is a partnership, the partnership name should be used and not the names of the
partners. However, for a "registered organization" like a corporation or limited partnership, the financing
statement must use the official name that is shown on the public records of the debtor's jurisdiction of
organization. Revised §9-503(a). The revision expressly rejects the view that use of a trade name is either
necessary or sufficient. Revised §9-503(b)(1) &amp; (c).

</p><p>The most significant change is in the collateral description requirement. As noted above, revised
§9-108 slightly relaxes the standard for measuring the adequacy of descriptions. However, revised
§9-504(2) goes further and expressly validates a supergeneric "all assets" or "all personal property"
indication of collateral in the financing statement. Since there is no prohibition against including an
over-broad collateral indication in the financing statement (as long as it is authorized by the debtor) and
since an "all-assets" financing statement will provide maximum protection, lenders likely will file
"all-assets" financing statements even when the transaction is more limited in scope.

</p><p>A financing statement is not rendered ineffective by minor errors or omissions in either the debtor's
name or the collateral indication unless they make the financing statement "seriously misleading."
Revised §9-506(a). Although this standard is similar to the test under current law, the revision specifies
that a name error is seriously misleading unless a search under the correct name using the filing office's
search logic would disclose the defective financing statement. Revised §9-506(c). Finally, although there
is no statement in the text of the Act, the comments assert that "an error in the name of the secured party
or its representative will not be seriously misleading." Revised §9-506, comment 2. This comment, if
followed by the courts, effectively eliminates the secured party's name from the list of required contents.

</p><p>Although only a few items are required for sufficiency, the revised Act requires that the filing office
refuse to accept a financing statement that does not also include other information such as the mailing
addresses of the debtor and secured party, and information about the debtor's organizational status. Revised
§§9-516(b), 9-520(a). For example, if the debtor is an organization, the financing statement must indicate
the type of organization, the debtor's jurisdiction of organization, and its organizational identification
number. Revised §9-516(b)(5)(C). While a financing statement that fails to include all required information
should not be accepted for filing, if it is accepted, the omissions will not invalidate the financing statement.
Revised §9-520(c). However, an error in the additional information can result in subordination of the lien
in favor of a secured party or purchaser who reasonably relies on the incorrect information. Revised §9-338.

</p><p>The net effect of these changes in the bankruptcy context is that it will be very difficult to avoid a
security interest based on defects in the financing statement. If all-assets filings become common, only
serious errors in the debtor's name will provide grounds for avoidance under the §544 "strong arm"
power.

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

<p>Since last month's column, six new states have introduced legislation to adopt revised Article 9, for
a total of 26 states with pending bills. The number of states that have enacted the revision remains steady
at seven. The current enactment status of the revision is available at <a href="http://www.nccusl.org/factsheet/ucc9-fs.html&quot; target="window2">http://www.nccusl.org/factsheet/ucc9-fs.html</a&gt;