Flyover 4 – Maintaining Perfection

Transcript

We have covered the rules for how a creditor perfects its security interest. Once perfected, secured creditors need to worry about maintaining their perfection over time. There are five key events that may threaten perfection.

5 Threats to Perfection

First, time passes. Financing statements lapse five years after their filing. To continue its perfection, a secured creditor must file a continuation statement within the six months before the end of the five-year period. Filing a continuation statement adds another five years to the financing statement's effective time.

If the creditor does not file a continuation statement, it is deemed to never have been perfected against other secured creditors. It will be deemed to be perfected up until when its financing statement lapsed as against other judgment lien creditors. So, first, as time passes, the secured creditor needs to file continuation statements.

2. Debtor Changes Name

Second, the debtor may change its name. For example, Mary Smith legally changes her name to Mary Johnson. Because the Article 9 filing system is searched by the debtor's name, if the debtor's name changes, that may make the financing statement unfindable.

If the debtor's name changes such that the name listed on the financing statement becomes seriously misleading, then the secured creditor must file an amendment to the financing statement with the debtor's new name on it within four months of the name change.

If the secured creditor does not, the financing statement is not effective for any of the collateral acquired later than four months after the name change. This is important if the security interest extends to after-acquired property, such as account or inventory. The financing statement, however, remains effective for all existing collateral and collateral acquired before four months after the name change.

Recall that I discussed what constitutes seriously misleading when I set out the requirements for an effective financing statement. If the debtor changes its name, think about whether the new name makes the financing statement seriously misleading.

3. Debtor Moves

Third, the debtor may move. Because which state UCC filing system is to be used is based on the debtor's location, if the debtor moves out of that state, someone interested in lending to the debtor will search in the debtor's new state.

A secured creditor is tasked with updating the location of the filing. The creditor has four months after the debtor's move to file a financing statement in the new location. If the creditor does not file the new financing statement, it is deemed to never have been perfected against other secured creditors.

It will be deemed to be perfected up until when the four-month period ends as against judgment lien creditors. If a debtor moves, look for facts about whether the secured creditor filed a new financing statement in the new location.

4. Debtor Changes How It Uses Collateral

The fourth and fifth things that may happen are about the secured creditor's collateral itself, not about time passing or the debtor changing its name or moving. Fourth, how the debtor uses the collateral might change. For instance, assume the debtor sells office supplies. It may take a desk out of inventory and put in the back office of a store. That desk is now equipment.

Issues with perfection arise if the new way that the debtor uses the collateral changes the method of perfection. Inventory and equipment both are perfected by filing a financing statement.

In this example, the secured creditor needs to do nothing to maintain its perfection. But if the collateral changes such that the method of perfection changes, the secured creditor must perfect correctly to maintain perfection. If the secured creditor does not do so, the secured creditor will no longer be perfected in that piece of collateral.

Note that it is nearly impossible for the debtor to change how it is using collateral of the types of tangible and intangible personal property that require perfection by possession or control. If the debtor changes how it is using the collateral, which transforms how it's categorized by Article 9, consider whether the debtor needs to perfect in a different filing system.

5. Identity of Collateral Changes

Fifth and finally, the debtor may sell or barter the collateral. This will result in the collateral changing identity, that is, what it is. It will go from inventory, to an account, to cash, and then perhaps back to more inventory. We have learned that the security interest attaches to identifiable proceeds. But what about perfection? As with how the debtor uses the collateral, if the method of perfection does not change, the secured creditor does not need to do anything.

For example, if the debtor barters inventory for equipment, because both are perfected by filing a financing statement, the creditor does not need to do anything. But if the debtor barters inventory for copyright, because its interest in the copyright is perfected by filing in the US copyright office, the secured creditor will need to file with that office. It must do so within 20 days of the barter.

The secured creditor is always perfected in cash. If the collateral turns into cash, such as the debtor selling inventory for cash, the creditor remains perfected. But if the debtor then uses the cash to buy something else, like a copyright, the secured creditor has 20 days to maintain perfection in that new collateral.

The secured creditor only will need to do something to maintain perfection if its current filings do not encompass the collateral. Continuing with the copyright example, the secured creditor will need to file with the US copyright office. Again, changes in what the secured creditor's collateral is most often involve needing to file a revised financing statement to cover the collateral, or an entirely new financing statement in a different office. That is, changes in the use or identity of the collateral are about where the financing statement must be filed.

Overall, a secured creditor must be concerned about getting perfection and maintaining perfection. If you encounter a secured transactions question, look for facts about the debtor, its business, or the collateral changing after perfection, but before the debtor defaults on the loan. The facts provide clues that part of the issue is maintaining perfection.

Lesson Note

No note. Click here to write note.

Click here to reset

Leave a Reply