The following is a case update prepared by Professor Dan Schechter, Loyola Law School, Los Angeles, analyzing a recent decision of interest:
A bankruptcy court in Illinois has held that a financing statement that did not describe the collateral but instead simply referred to a security agreement was inadequate because that security agreement was not attached and the creditor failed to use a “supergeneric” collateral description. [In re I80 Equipment, LLC, 2018 Westlaw 4006294 (Bankr. C.D. Ill.).]
FACTS: A lender took a blanket security interest in a commercial borrower’s assets. The financing statement filed by the lender described the collateral as “All Collateral described in First Amended and Restated Security Agreement dated March 9, 2015 between Debtor and Secured Party.” The security agreement was not attached to the UCC-1.
The debtor defaulted on its debt of approximately $7.6 million. Following the debtor’s Chapter 7 filing, the lender sought declaratory relief concerning the validity of its lien. The trustee cross-complained, asserting her powers under 11 U.S.C.A. §544(a)(1). During the litigation, the trustee sold the estate’s assets for nearly $1.9 million and held the net proceeds, pending a decision. Both parties moved for judgment on the pleadings, and the trustee’s motion was granted.
The court first observed that this was a case of first impression:
Courts have routinely held that creditors may incorporate by reference security agreements into financing statements, where the security agreement is identified in and filed with the financing statement, and that such incorporation satisfies the collateral description requirements for financing statements under Article 9 of the Uniform Commercial Code (UCC) . . . . [The lender] takes the position that a financing statement’s identification of the security agreement as the document containing the description of the collateral, without filing it as part of the financing statement and without setting forth any collateral description in the financing statement, is nevertheless sufficient to perfect its security interest. The parties agree that no published opinion by any court addresses this exact issue.
Turning to the Illinois version of Article 9, the court noted that under §9-502(a)(3), a financing statement is valid only if it “(3) indicates the collateral covered by the financing statement.” In turn, §9-504 provides that a financing statement sufficiently indicates the collateral it covers if it provides either “(1) a description of the collateral pursuant to Section 9-108” or “(2) an indication that the financing statement covers all assets or all personal property.”
The lender argued that §9-108(b)(6) authorizes descriptions by “any other method, if the identity of the collateral is objectively determinable.” Under that reasoning, the reference in the financing statement to the security agreement was an “other method.” The lender reasoned that the debtor’s other creditors were on notice of the existence of the lien and that further inquiry was required.
The court disagreed:
[The] financing statement does not describe the collateral. Rather, it attempts to incorporate by reference the description of collateral set forth in a separate document, not attached to the financing statement. The financing statement, on its face, provides no information whatsoever, and therefore no notice to any third party, as to which of the Debtor’s assets [the lender] is claiming a lien on, which is the primary function of a financing statement.
Ouch. A creditor secured by almost $2 million in assets became an unsecured creditor, due to a clerical oversight. Technically, I think the court reached the right result; but it seems terribly unfair. If the collateral description in the financing statement had said “all assets,” it would have been enforceable because it would have put the debtor’s other creditors on inquiry notice. But instead, it said “all of the assets described in the security agreement.” In the real world, if you were getting ready to extend credit to a debtor and you had found that UCC-1, wouldn’t that prompt you to make inquiry as to the exact scope of the assets covered by the lien?
But never mind. This case provides another example of the proverbial “crucible of bankruptcy” that lienholders must survive. Lenders must assume that their documentation will be subject to intense scrutiny and that the bankruptcy courts will not treat them leniently.
The solutions are obvious: first, if a collateral description in a financing statement depends on a description contained in another document, attach that document as an exhibit to the UCC-1. Second, consider using preprinted UCC-1 forms containing supergeneric collateral descriptions. Third, make sure that your lending personnel are aware of the severe consequences flowing from sloppy paperwork.
For discussions of cases dealing with related issues, see:
- 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.