Business Law

In re Financial Oversight and Management Board for Puerto Rico (1st Cir.)

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The following is a case update prepared by Dan Schechter, Professor Emeritus, Loyola Law School, Los Angeles, analyzing a recent decision of interest:


The First Circuit has held that although the original financing statements pertaining to a $2.9 billion bond issuance failed to describe the collateral, the bonds were properly secured because the subsequent amendments to the financing statements eventually cured the defects. [In re Financial Oversight and Management Board for Puerto Rico, 2019 Westlaw 364029 (1st Cir.).]

Facts: The trustees of a public employees’ retirement system adopted a resolution authorizing the issuance of $2.9 billion in bonds. The resolution itself contained a description of the collateral for those bonds. Unfortunately, the security agreement executed on behalf of the bondholders did not describe the collateral at all; instead, it simply referred to the resolution. The resolution was not attached to the security agreement, nor did the security agreement say where the resolution could be found.

The UCC-1 financing statements filed on behalf of the bondholders also contained no description of the collateral. The security agreement, which itself contained no description of the collateral, was attached to the financing statements.

Some years later, amendments to the financing statements were filed. The amendments contained adequate descriptions of the bondholders’ collateral. After the filing of the amendments, Congress passed legislation to deal with the Puerto Rican financial crisis. That legislation incorporated portions of the Bankruptcy Code, including 11 U.S.C.A. §544(a), which empowers a trustee in bankruptcy to challenge unperfected security interests.

The Financial Oversight and Management Board filed an action for declaratory relief against the bondholders, asserting that the bondholders were unsecured because the original financing statements were defective. The trial court granted summary judgment in favor of the Board.

Reasoning: The First Circuit reversed, holding that although the original financing statements were defective, the amendments cured the defect. The court discussed the shortcomings of the original financing statements:

[The original] Financing Statements do not describe even the type(s) of collateral, much less the items, at issue. They also do not attach the document (the Resolution) referenced as describing the collateral. Nor do those facts alone define the issue before us. In addition, the referenced document — the Resolution — was held in a different location from the UCC filing office, and the [original] Financing Statements (including the attached Security Agreement) contain no indication of the referenced document’s location or how to find it.

The court then held that this description would not have provided sufficient guidance to a subsequent searcher:

This at best gives an interested party notice about an interest in some undescribed collateral, but does not adequately specify what collateral is encumbered . . . . Requiring interested parties to contact debtors at their own expense about encumbered collateral, with no guarantee of a timely or accurate answer, would run counter to the notice purpose of the UCC . . . .

It would not have been difficult whatsoever for the [original] Financing Statements to provide proper notice. The Resolution could simply have been attached to these filings, as the Security Agreement was. Instead, as they stand, the [original] Financing Statements would leave a reasonable creditor or interested party with doubts as to the collateral at issue.

Nevertheless, the subsequent amendments to the financing statements rescued them from avoidance. The court held that the original financing statements had not lapsed and that the description of the borrower’s name, while problematic, was good enough to alert a subsequent searcher as to the identity of the parties.

Author’s Comment: The court did not explain how a $2.9 billion bond issuance was jeopardized by such a basic rookie mistake. But the court gave us a hint:

The Security Agreement specified that “[the borrower] shall cause UCC financing and continuation statements to be filed, as appropriate, and the Secured Party shall not be responsible for any UCC filings.”

Not responsible? Bad idea. A creditor should never rely on the borrower to protect the creditor. The very same “let’s trust the debtor” strategy was responsible for the General Motors debacle. See 2015-04 Comm. Fin. News. NL 8, Lender Inadvertently Authorized Filing of Erroneous Termination Statement, Invalidating $1.5 Billion Security Interest. At the very least, the creditor has to skeptically review the documents prepared by the borrower before they are filed.

For discussions of other cases involving security interests jeopardized by inadequate collateral descriptions, see:

  • 2018-46 Comm. Fin. News. NL 92, Financing Statement That Did Not Describe Collateral but Referred to Security Agreement Was Inadequate Because Security Agreement Was Not Attached and Creditor Failed to Use Supergeneric Collateral Description.
  • 2018-25 Comm. Fin. News. NL 49, Although Senior Creditor’s Collateral Description in Financing Statement Seemed to be Confined to Assets Located at Specific Address, Ambiguity Created Duty of Inquiry by Junior Creditor.
  • 2018-22 Comm. Fin. News. NL 43, “Supergeneric” Financing Statement Is Sufficient to Perfect Security Interest in Liquor License.
  • 2009 Comm. Fin. News. 23, “All Assets” Financing Statement Is Sufficient to Perfect Security Interest, Even Though Collateral Description Is Grossly Inaccurate.

These materials were written by Dan Schechter, Professor Emeritus, Loyola Law School, Los Angeles, for his Commercial Finance Newsletter, published weekly on Westlaw. Westlaw holds the copyright on these materials and has permitted the Insolvency Law Committee to reprint them.

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