The Quest for Perfection: A Secured Creditor's Guide to the New Article 9

Just when you think you’ve finally learned Uniform Commercial Code (UCC) Article 9, the Uniform Law Commission (ULC) proposes changes. The ULC and the American Law Institute (ALI) promulgated Revised Article 9 (RA9) in 1998, and it was enacted by all states by 2001. From 2001-08, RA9 seemed to work fairly well, but some practitioners and judges nevertheless found ambiguities.

To set the record straight, the ULC and ALI formed an Article 9 Review Committee, which spent one year reviewing Article 9. First presented for draft consideration in July 2009, it was adopted on July 15, 2010. The present goal is to get legislatures [1] to consider the new Article 9 in 2011 and for changes to be officially effective in each state on July 1, 2013. This article provides a roadmap through the changes to the new Article 9 (2013 RA9).

Mulling over Modifications
The committee set standards for proposing revisions to RA9, focusing on issues where ambiguities were found in the statutory language and clarified them with changes to the comments rather than the statutory text. The committee also preserved the policies set forth in the 1998 revision, so there would not be an entire overhaul of RA9. Generally, the committee sought to clarify and enhance predictability as to perfection and priority and to do so without a huge investment in implementation. Most of the significant 2013 RA9 changes are related to the debtor’s name, status or location. The remaining changes are relatively minor or highly specialized.

What’s in a Name? Everything (Changes in Naming Conventions)
Section 9-502 states that a financing statement is only sufficient if it (1) provides the name of the debtor, (2) provides the name of the secured party [2] and (3) indicates the collateral covered by the financing statement. The financing statement must be filed in the proper location.

Name insufficiency seems to be one of the most common causes for improperly perfected filings. Section 9-503 illuminates the sufficiency requirements by defining the name of the debtor that must appear on the financing statement. Individuals and organizations are subject to new rules under 2013 RA9.

Registered Organizations
Section 9-503(a)(1), which covers organizational debtor names, is clarified rather than significantly revised. It now reads that a registered organization’s name on a financing statement sufficiently provides the name of the debtor if “only if the financing statement provides the name that is stated to be the registered organization’s name on the public organic record most recently filed with … the registered organization’s jurisdiction of organization which purports to state … the registered organization’s name.” [3]

The definition of registered organization [4] under 2013 RA9 now comports with corporate formation procedural requirements. An organization is a registered organization if it is formed or organized by filing a public document, rather than merely maintaining such a document with the state. Not every record concerning a registered organization, such as a certificate of good standing, is a public organic record. The term “registered organization” includes corporations, limited partnerships, limited liability companies, Massachusetts business trusts, etc. It is now clear that a registered organization is any organization whose “birth certificate” derives from a public filing act.

There may be a practical issue when the state’s searchable database uses abbreviations or has limited-filed codes. To be clear, the creditor [5] should file the financing statement using the name that appears on the charter document. Out of an abundance of caution, the creditor should also file the financing statement providing one name as the debtor [6] and one name as an additional debtor. If there are changes to the organization’s name on record, then use the one provided on the most recently filed public organic record. If the entity has converted to another form, it would be prudent to add the resulting organization as an additional debtor.[7]

Unincorporated Organizations
For an unregistered organization that goes by a name, the secured party must file using the debtor’s organizational name. However, if it is an unnamed and unregistered organization, then the creditor must include all of the names of all of the partners, members, associates, etc., on the financing statement. The rules for determining an individual’s name as stated below apply to the names of the partners, members, associates, etc., that make up the unnamed and unregistered organization.

Individual Debtors
Naming conventions for individual debtors are entirely new under 2013 RA9. Many problems arose under previous versions of UCC Article 9 because an individual does not typically have one single official name. There is rarely one definitive source for an individual’s name and the debtor may use a “nickname” that has no relationship to his or her official name. To resolve this uncertainty, the committee created new rules set forth in two options: (1) the “Only If” Rule (Alternative A) and (2) the “Safe-Harbor” Rule (Alternative B).

Under the Only If Rule, found in § 9-503(a)(4), the debtor’s name is sufficient only if the name provided on the financing statement is the name on the driver’s license. If the debtor holds a driver’s license that has not expired and has been issued by the debtor’s state of residence,[8] then that is the sufficient name. When filing the financing statement, be sure to set forth the surname and first personal name appropriately. Be alert because some states print names in different orders, which may not be readily apparent and some additional investigation may be necessary. If the debtor does not hold an unexpired license, his or her surname and first personal name will suffice.

An unexpired driver’s license from a state other than debtor’s state of residence would be insufficient. Additionally, if there are multiple licenses or identification (ID) cards, the most recently issued ID is the one to use, but once the license expires, the name on the financing statement becomes insufficient. A creditor will need to amend the financing statement within the four-month grace period to maintain perfection without losing priority. Manage the problem of expiring licenses by maintaining a copy of the license on file and note the expiration date for further action.

Under the Safe-Harbor Rule, there are three paths to name sufficiency: (1) use the debtor’s name shown on an unexpired license issued by the state, (2) use the debtor’s name as under RA9 or (3) use the debtor’s surname and first personal name.

Practical Practice
Sound confusing? The good news is that you have the power to influence your state legislature as to which alternative to choose. Alternative A provides certainty while Alternative B provides flexibility. The lending community that participated in the 2013 RA9 revision felt that the risk of periodic changes to the debtor’s name due to relying on the license was negated by the certainty that either rule would create.

In practice, the more significant your transaction, the more diligent you should be. If there is any doubt about an individual debtor’s name, a creditor should file more than one financing statement to cover the possibilities.

For creditors handling interstate transactions, note that sufficiency of filing, perfection and priority are determined by the law of the jurisdiction in which the debtor is located. Thus, the law of the state of the debtor’s principal residence will control even if debtor holds a license from a state that is not his or her principal residence. Business communities that are closely connected across state lines are likely to pose the most problems. Stay abreast of any changes to debtor’s principal residence because you have only four months to discover the change and re-perfect in the new state.

Name Changes
The naming conventions under 2013 RA9 will be discussed, but the name can always change and this could affect your status. Under § 9-507(c), a debtor’s name on a financing statement that once was correct can become insufficient such that it is seriously misleading if the debtor changes its name. A creditor has four months to discover and amend the financing statement to reflect the change. While this may seem administratively burdensome, the drafters thought that it eased the search burden and added certainty. If the secured creditor must update the debtor’s name and it has already filed an initial financing statement, then the amendment filed under § 9-509(d) need not be an authenticated record.[9]

The name of the debtor to be provided on a financing statement is the “correct” name. This is true even if the debtor is known in some contexts, or commonly known in the community, by a nickname or a trade name. You may also encounter cross-cultural challenges in your efforts to confirm naming conventions. These and other potential disputes about interpretation will be decided under outside law (unless the result conflicts with the intent of 2013 RA9).

Grace under Pressure: Changes to Location of Debtor or Collateral.
Under § 9-515 of 2013 RA9, a financing statement is generally effective for five years after the filing date. A creditor may file a continuation statement within six months before the expiration of the five-year period. However, do not be too hasty; any continuation statement filed earlier than six months before the lapse date is ineffective.[10] These rules are no different from RA9 and creditors should note these important dates. If you will not be managing this for your client, you should include it in your list of deadlines and continuing activities in your end-of-engagement letter.

AAP in a New Location
Under the new § 9-316(h), which addresses security interests that attach after the debtor changes location, [11] a creditor that perfected by filing at an earlier date in the first state does not lose its position. For the uninitiated, the concept of gaining an interest in collateral after executing documents or post-relocation may seem strange. So, a brief tutorial on after-acquired property follows.

Under § 9-204, a security agreement[12] may provide that some obligations are to be secured by after-acquired property as additional collateral (AAP), which typically occurs when a creditor finances a debtor’s inventory. The creditor takes a security interest in debtor’s inventory or accounts and, as the inventory is sold and rotates through, creditor’s security interest attaches to the new inventory, thereby protecting its security interest. For example, if debtor grants lender a security interest in “all equipment,” then the interest attaches only to the equipment that debtor owned at that time. Without the AAP language, the security agreement and corresponding financing statement will not cover AAP, which could result in decreased value of the secured party’s collateral over the course of the indebtedness.

AAP continues to work in this same manner. What is different under 2013 RA9 is that the four-month grace period now (1) continues perfection on current assets post-relocation and (2) allows the creditor’s interest to attach to newly acquired property post-relocation. The new § 9-316(h) overrides the old § 9-326 [13] in RA9.

The new § 9-316(h) allows the creditor’s security interest to attach to AAP during the four-month grace period as if the debtor had not changed location, which is significant because under RA9, there is no grace period for post-relocation AAP. If the secured party re-perfects under the law of the new state before the other filing would have lapsed or within the four-month grace period (whichever is earlier), then the security interest remains perfected. It clarifies that a change in the debtor’s location no longer cuts off a creditor’s rights to AAP after a debtor moves. It serves to protect the creditor’s interest while giving the creditor time to discover that the debtor has moved.

The practical effect is that if the new creditor is not a buyer in the ordinary course of business (BIOCOB), he or she will need to search in the old location for any prior filings and may want to try to get a release from the original creditor as to the property that he or she lent against during the four-month grace period. The original creditor in the original state beats out any creditors in the new state that may have tried to swoop in to lay claim to AAP in the new state. A fortuitous change in location now cannot benefit a later-filing creditor until after the four-month grace period has lapsed.

New Debtor in Same Location
The new § 9-316(i) covers collateral acquired by a new debtor.[14] It addresses security interests that attach within four months after a new debtor becomes bound as well as collateral acquired during the gap period. Under new subsection (i), a financing statement filed in the original debtor’s jurisdiction would be effective with respect to the collateral acquired by the new debtor both before and during the four months after the new debtor becomes bound. The most common situation in which subsection (i) would be applicable would be in a corporate merger where the surviving company assumes the old debtor’s debt.

Transferred Collateral
In the case of a transfer of collateral to a transferee located in another jurisdiction, the secured party has a one-year grace period to file in the name of the transferee under RA9 9-316(a)(3). A transferee is a person other than a secured party or other lienholder who, in a voluntary transaction, acquires a property interest in collateral.[15] Transfers arise in sale situations, whereas new debtors arise in merger or conversion situations. If the debtor is selling collateral to a non-BIOCOB, the creditor’s interest remains enforceable against the buyer during this one-year grace period, but the creditor must take action to re-perfect. [16]

Location, Location, Location: Where to File
Section 9-307 covers the debtor’s location, which determines where the creditor should file the financing statement. For the most part, location rules have remained the same. Section 9-307(b) covers the individual debtor’s location, which is his or her principal residence and includes sole proprietorships.

A registered organization’s location is determined under § 9-307(e). If the organization is organized under state law, then it is located in that state. The lender must look to the public organic record as defined in § 9-102(a)(68) to determine the name and location of filing.
If the group is organized, but not registered and only conducts business in one place, the proper location is the location of the business. If the same unincorporated organization has multiple places of business, the appropriate location in which to file the financing statement is in the state from which debtor’s chief executive office manages the main part of its business operations.[17]

The most significant change is found in § 9-307(f) where an organization registered under federal law may designate its main office, home office or other comparable office. The drafters have adopted Delaware’s non-uniform revision to the code. Earlier comments had addressed this issue, but now the comments have the force of law by being incorporated into the statute.

Right to Report: Who May File or Correct a Financing Statement?
A perfectly completed financing statement is of no effect without debtor’s authorization to file it. Initially, a creditor must obtain permission to file an originally authenticated document. Under § 9-509(d), Official Comment 6 is amended to clarify that authorization to file a financing statement, which is amended (but not amended to add additional collateral) need not appear in an authenticated record. Conversely, if there is an amendment under § 9-509(a), which does add collateral, the authorization must appear in an authenticated record.

A debtor may challenge an authorized financing statement by filing an information statement. On the creditor’s side, there is some relief because Official Comment 4 to § 9-322 now clarifies that a financing statement originally filed without authorization can be later ratified by the debtor. This ratification makes the FS retroactively effective. However, the priority is not retroactive—priority is only available from the date of filing.

The misnamed “Correction Statement” has been re-named an “Information Statement” in § 9-518. The purpose of the information statement is to publicly object to a financing statement that the debtor believed was improperly filed. However, many debtors attributed to this greater legal effect than mere notice, and some creditors even tried to undo mistakes by filing correction statements. By renaming these statements, it is now clear that the real purpose is to merely provide information to other searchers. Both debtors and secured parties now have the authority to file.

Conclusion
Overall, the changes found in 2013 RA9 serve to clarify procedure and secure expected outcomes. Implementing the changes to protect your interest will require some new administrative procedures and calendar items. If you meticulously follow a standardized approach to UCC transactions, you will have a more uniform result. Ultimately, uniformity and expected outcomes save lawyers time, clients money and create better case law.

Creditors can use these changes as an opportunity to get to know their clients (debtors). Be sure to check ID (and keep a photocopy) and ask questions about a debtor’s future plans that may trigger changes, such as marriages, moving or other life events. Keeping track of these events can provide an opportunity to build customer relationships as well as keep an eye on your collateral.