Flyover 3 - Perfection

We have covered attachment, which gives a creditor an enforceable security interest in collateral. Attachment is about the deal between the debtor and the secured creditor. Now, we're going to talk about perfection of a security interest.

Perfection is the act that the secured creditor takes to publicly tell other parties of its rights to the collateral. Perfection is about the secured creditor in relation to other parties who may be interested in the collateral.

Financing Statement

To perfect, a secured creditor must meet two requirements: first, it must have an enforceable security interest; second, it files a financing statement or takes steps to possess or control the collateral. How a secured creditor perfects depends on the type of collateral.

Most types of collateral require the filing of a financing statement. Filing is required for goods, equipment, inventory, accounts, and general intangibles, such as copyrights. For almost all property that requires a financing statement, the office to file the statement is the secretary of state, which maintains the UCC filing system in every state.

The state for filing is determined based on the debtor's location. People are located where they live; registered organizations like a corporation are located in the state of organization; non-registered organizations are located in their place of business. If there are multiple places of business, they are located at the chief executive office.

There are a few notable exceptions from using the Article 9 filing system. For automobiles, the certificate of title must be filed in the automobile title system; for patents and trademarks, the filing office is the United States Patent and Trademark Office; and for copyrights, the filing office is the United States Copyright Office.

Again, for most types of collateral, the secured creditor will need to file a financing statement in the UCC filing system in the relevant state. The state is based on the debtor's location.

Debtor's Name

The financing statement must contain some key information for it to be effective. Most important is the debtor's name. If the debtor's name is incorrect such that it is seriously misleading, the financing statement does not perfect the security interest. For people, the debtor's name is their first and last name. For registered organizations, it is the name on the certificate that accompanies its state registration. For partnerships and unincorporated organizations, it is the name by which the business is known in the community. Trade names cannot be used.

If the name is not listed correctly, whether the financing statement will be effective depends on the search logic of the UCC filing system in the state. Search logic refers to what will appear on a search by a third party of the UCC filing system if the correct debtor name is searched. If the incorrect name on the financing statement will show up on the search, the name is not seriously misleading and the financing statement is effective, provided it contains all other required information.

Most UCC filing systems' search logic ignores punctuation, capitalization, and ending words, such as "incorporated." For example, if the correct name is "Standard Bricks, an Illinois Corporation," but the financing statement lists "Standard Bricks," that technically incorrect name is not seriously misleading.

The most important item of information on the financing statement is the debtor's name. If you encounter a question about perfection, consider how the debtor's name was listed.

Secured Name + Collateral Indication

In addition to the debtor's name, for a financing statement to be effective, it also must include the secured creditor's name and a collateral indication. The secured creditor's name is subject to the same "seriously misleading" standard as the debtor's name. Because the secured creditor usually is filing the financing statement, its name typically is correct.

The collateral indication also must not be seriously misleading. To not be seriously misleading, it must reasonably identify the collateral. To do so, the indication can simply be "all assets," or "all personal property." The financing statement also can list the same collateral as in the security agreement's collateral description, or it can list the collateral based on UCC categories.

Note that the standards for the financing statement's collateral indication are different than the standards for the security agreement's collateral description. Recall that security agreements' collateral description cannot be super generic. The collateral indication can be super generic.

To recap, there are three items of information that must be on the financing statement for it to be effective: the debtor's name, the secured creditor's name, and a collateral indication.

Filing Office Acceptance

There are three other items of information that must be on the financing statement for the filing office to accept it. They are the mailing address of the secured creditor, the mailing address of the debtor, and an indication of whether the debtor is an individual or an organization.

If the financing statement is missing any of these three items, the filing office can correctly reject it. A correctly rejected financing statement is not effective. What happens if the filing office incorrectly rejects a financing statement it should have accepted? In that scenario, the security interest will be deemed to be perfected against judgment lien creditors.

It will not be deemed to be perfected against any other creditors who give the debtor security interest for value, that is, other secured creditors who are presumed to search the UCC filing system prior to extending credit and taking a security interest in collateral.

Similarly, what if the filing office accepts a financing statement that it should not have? If the secured creditor's address is incorrect, it doesn't matter. The financing statement is effective. If the debtor's information is incorrect, the security interest will be deemed to be perfected against judgment lien creditors, but it will not be deemed to be perfected against other secured creditors. Note this is the same rule as the incorrectly rejected financing statement.

So, a fully filled-out financing statement will include six items of information. Three items are not necessary for it to be effective: the mailing address of the secured creditor, the mailing address of the debtor, and whether the debtor is an individual or an organization. But if any of those are missing or incorrect, the filing office should reject the filing.

If it is accepted, and either of these two pieces of information about the debtor are incorrect, the financing statement will not be effective as against other secured creditors.

Other Ways to Protect

Most types of collateral require the filing of a financing statement. But there are a handful of exceptions. There are two other ways to perfect: possession and control.

Possession

Possession refers to the secured creditor having physical control of the property. Possession can include having a third party, like a trustee, control the property. There are five types of collateral that can be perfected with possession. They are money, goods, certificated securities, instruments, and tangible chattel paper.

Money and goods are self-explanatory. A certificated security is a bond, share, or other interest in property or a company represented by a written instrument; for instance, a paper share of stock. An instrument is a writing that evidences a right to payment in the future; for instance, a loan agreement. Some instruments are termed negotiable instruments. Negotiable instruments still are instruments.

Chattel paper is a document that evidences both a monetary obligation and a security interest in a specific good or in specific goods. Tangible means there is a physical document. Notice that a security interest in chattel paper is a security interest in a security interest. Remember that there are five types of tangible personal property that must be perfected with possession: money, goods, certificated securities, instruments, and tangible chattel paper.

Control

Control is similar to possession. The key difference is that the term applies to property that is intangible. It is impossible to possess intangible property as the term possession is used in Article 9. Instead, the secured party needs to control the intangible property. There are three main types of collateral that are perfected with control: deposit accounts, electronic chattel paper, and uncertificated securities.

Deposit accounts are what are informally called bank accounts; electronic chattel paper is chattel paper without a physical document; and uncertificated securities are bonds, shares, or other interests in property or a company that are not evidenced by a written instrument. Remember that for three types of intangible personal property, they must be perfected with control: deposit accounts, electronic chattel paper, and uncertificated securities.

Automatic Perfection

Finally, there is one category of collateral that automatically perfects, meaning the secured creditor does not need to do anything to perfect. That category is purchase-money security interest in consumer goods. As a reminder, a purchase-money security interest is created when a debtor purchases property with the money loaned by the creditor taking the security interest in that property. Recall also that consumer goods are goods that are used or bought for use primarily for personal, family, or household purposes.

Overall, if you encounter a perfection question on the exam and you are unsure if you remember the correct method of perfection, there's a good chance that filing a financing statement is the way to perfect. The exam question also may include facts about possession or control or that the debtor is a consumer that you can use as clues that some other means of perfection, including automatic, is the way to perfect in particular collateral.

The next lesson we'll discuss how a secured creditor maintains perfection.