Beware of Priming Liens: Four Common Types of Priming Liens and Interests

In an insolvency situation, a lender’s strategy is very dependent upon the nature and extent of its collateral. Nothing can be more frustrating to a lender than believing it is in a senior position, only to find out that it has been primed. While a standard UCC Article 9 search will discover most liens and security interests, certain liens and interests require enhanced diligence. Four common types of liens and interests that require such enhanced diligence are discussed here.

IRS Tax Liens

One of the first creditors a struggling borrower will stop paying is the federal government. For example, it is not uncommon for a struggling borrower to cease paying employment and payroll taxes. The failure to pay taxes will result in the government filing a Notice of Federal Tax Lien (NFTL).[1] Depending on state law and the type of property, the NFTL will either be filed locally or at the state level.[2] Accordingly, an NFTL might not appear in an Article 9 search at the secretary of state’s office.

Federal tax liens can have substantial impact on an Article 9 lender, especially a lender whose primary collateral is accounts and inventory. For instance, even if the lender has an after-acquired property clause in its security agreement, its security interest may only remain superior to the federal tax lien with respect to property acquired in the 45 days after the NFTL was filed.[3] After that date, the tax lien may prime the consensual security interest. This is known as the 45 Day Rule.

As a best practice, the lender should, on regular basis, require proof that the borrower is current on all of its tax obligations. The borrower’s failure to provide such information serves as a red flag. Additionally, a lender should be familiar with where tax liens may be filed and do periodic searches. This is especially important for loans structured as a line of credit and that rely upon a borrowing base.

Agricultural Landlord Liens

In several states, landlords have a lien on the crops grown on the leased premises in order to secure rent. Depending on the state, such liens may prime a prior perfected Article 9 security interest in crops. Further, in order to get priority status, certain states may require specific filings to be made by the landlord, whereas in other states, no filing is required.[4] These liens may also have limited duration.[5]

As a best practice, the lender should, on a regular basis, require proof that the borrower is current on its rent obligations. Not providing proof of tax payments, and failure to provide proof of rent payments, serve as red flags. Additionally, the lender should understand the laws of the state where the crop is located and whether it provides for priming landlord liens.

Agricultural Input Liens

Input liens are another common lien in the agricultural industry. Under state law, different suppliers of goods and services may have a lien on crops or livestock. For example, a person who provides feed or services for livestock may have a lien on the livestock that benefitted from the feed or services. Similarly, a company providing seed or fertilizer may have a lien on the crops produced from those inputs.

The supplier may need to make certain filings to perfect their liens, with the location of such filings varying by state.[6] As with landlord liens, state law will dictate whether those input liens have priority over previously filed security interests.

PACA Trust

The Perishable Agricultural Commodities Act (PACA) was enacted to protect produce suppliers. PACA establishes a trust, where the merchant, dealer or broker holds the produce, as well as the receivables and proceeds generated from the sale of such produce, in trust for the benefit of the unpaid suppliers and sellers until the suppliers or sellers are paid.[7] The produce supplier or seller must provide written notice of its intent to preserve the benefits of the trust to the merchant, dealer or broker.[8]

Because the assets are held in trust, PACA “provides unpaid suppliers with priority over secured lenders with regard to PACA trust assets held in trust by produce purchasers.”[9] If a lender is dealing with a struggling supermarket, restaurant or produce wholesaler, it should especially be on guard for potential PACA issues.

Ignorance Is Not Bliss

In crafting its litigation strategy, a secured lender must be aware of any priming liens or interests that may exist. This requires the lender to not only know its borrowers’ business and financials, but also what jurisdiction’s law applies. Failure to do so will result in unwanted surprises and disappointment.