assignment of ucc security interest

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Understanding article nine of the ucc – security interests.

By Michael A. Stover, Esq.

In this Surety Today Blog post we will discuss Article 9 of the Uniform Commercial Code (“UCC”). Article 9 covers security interests in all personal property whether tangible or intangible. We will discuss what security interests are, what is required for perfection and the priorities afforded security interests.

Section 9-109 of the UCC defines the scope of Article 9 and identifies what is included and also lists what is not included.  The primary innovation of Article 9 is that it establishes a uniform and orderly method for obtaining a security interest in collateral by standardizing the forms, process and procedures.  This standardization allows for greater certainty in one’s security interest and greater ability to search for and locate other interests that may exist in the debtor you are dealing with.

Article 9, like other UCC titles, is laid out with a number of subtitles.  It begins with a subtitle addressing general provisions and definitions, the next subtitle deals with effectiveness of security agreements and attachment, the largest subtitle in Article 9, not surprisingly, deals with perfection and priority.  That subtitle is followed by subtitles addressing the rights of third parties, the filing requirements and procedures and finally default.

First, let’s look at security interests and perfection.  These issues are relevant for a surety claims handler in the event you are filing your own security interests (not recommended) or in the event you need to evaluate other security interests to see if they are valid and entitled to a higher priority than your security interest or other rights.

The first concept to discuss is the “security agreement.”  A security agreement is a written document that conveys a security interest.  UCC § 1-201(35) defines a “Security Interest” as “an interest in personal property or fixtures that secures payment or performance of an obligation.”  In the context of suretyship, the security agreement is usually found in the Indemnity Agreement.  Although the security agreement is sometimes an elaborate document negotiated between the debtor and creditor, it can be as informal and as simple as a single page or paragraph.  There is no magic form or format.

The primary purpose of a “security agreement” is to show, to an objective observer, that the debtor intended to transfer an interest in personal property as a security to a creditor.  A security agreement must contain a description of the collateral.  UCC § 9-108 requires that the description of the collateral provide “reasonable identification” of the property.  Examples of what is considered to be reasonable identification include identification of the collateral by specific listing, category, by type of the collateral defined in the UCC, by quantity, computational formulas or other procedures, as long as the identity of the collateral is “objectively determinable.”  Section 9-108(c) states that “super generic” descriptions such as “all the debtor’s assets” or “all the debtor’s property” do not reasonably identify the collateral for purposes of a security agreement.

The next concept to discuss is “attachment.”  For a security interest to be enforceable it must “attach” to the collateral.  UCC § 9-203 sets forth the requirements for attachment and enforceability of security interests.  In general: (1) the creditor must give value, (2) the debtor must have rights in the collateral, and (3) there must be a security agreement or other action indicating an intent to convey a security interest.  Once the security interest has “attached,” it is effective between the debtor and the creditor.

This brings us to the next concept – “Perfection.”  Perfection is the step necessary to place the world on notice that a creditor has an interest in the collateral.  Perfection is also necessary to give a creditor priority with respect to other creditors over the same collateral. Typically, perfection is achieved by filing a document called a “financing statement,” sometimes referred to as a “UCC 1.”  The financing statement must identify the debtor, the creditor, and the collateral against which the creditor has a claim.  Unlike Security Agreements, the financing statement only needs to provide an “indication of the collateral” that is covered.  Section 9-504 of the UCC states that a financing statement may use the super generic identification of collateral such as “all assets” or “all personal property,” which is directly contrary to the security agreements, which do not allow that.  So, the UCC adopts the approach of “Notice Filing” which only requires a simple record with a limited amount of information for notice purposes.  An interested party must then inquire further to obtain the details of the secured transaction and collateral covered.  The financing statement need not be signed by the debtor and will be effective for five years after filing.

There are different methods of perfecting. You can always file a UCC-1.  Every single time, it will not hurt you to file a financing statement.  That is always permissible.  But, a UCC-1 is not the correct form of perfection for several asset categories and your interest will not be protected if you do not perfect properly.

The other categories of assets where the UCC requires something more than a UCC-1 includes assets like cash, negotiable instruments, which include promissory notes, drafts and checks.  These forms of assets require “possession” of the collateral in order to perfect your security interest.  Possession is also required for chattel paper, which is the combination of a promissory note and a security agreement, such as what you would find if you were financing the purchase of furniture in a retail transaction for example.

Other forms of collateral require “control” as the means of perfecting a security interest.  Deposit accounts, including a savings account, checking account, or a similar account at a financial institution all require control.  You often see in a commercial loan arrangement that the bank requires the debtor to keep all of their operating accounts within that bank so that they have that control.

As far as what the surety is looking for and the main assets that you would see with the principal, there is the “big three” and that is inventory, equipment and accounts receivable.  Those are all going to be covered by the filing of a UCC-1.  A surety may also frequently see payment intangibles and general intangibles, which may relate to different contract rights, that the principal has for an executory contract or funds for work performed.  Another asset that might pop up in this commercial arena is a legal claim.  For example, if a principal has a claim arising out of a project that may somehow be related, that is something a surety might have an interest in also.  All of those are going to require the filing of a UCC-1 financing statement to achieve perfection.

Now let’s focus on priorities among various security interests and other types of liens.  Because of the priority system, your security interest or your lien is only as good as your place in line.  We are talking about situations where two creditors have an interest in the same exact collateral.  I point that out because as noted above a UCC-1 is permitted to simply say “all of the debtor’s assets” or “all of the debtor’s personal property” so it may not be immediately obvious what a security interest is in when you do a basic public records search.  You will get a good idea of who has the security interest, but you have to do a little bit more research to get a hold of competing security agreements and sort out whose interest is in what.  So, assuming that we’re talking about that same collateral, there are a couple of different basic rules regarding priority.

Under § 9-322 if you have a perfected security interest and somebody else has an unperfected security interest, the perfected party wins.  If you have two perfected security interests, the winner is whoever was first to perfect.  The third rule is if you have two secured parties who have attached, but neither of whom has perfected, whoever attached first wins.  Things can get a little more complicated under § 9-317, which addresses a conflict between an Article 9 creditor and a creditor arising under some other law, either a judgment creditor who is attempting to levy on collateral or a bankruptcy trustee, who is marshalling assets for the benefit of the estate.  In these cases, in order to win as an Article 9 secured creditor against either of those outside parties, you need a signed security agreement with an adequate description of the collateral along with that perfection by filing a UCC-1 before the levy takes place or before the bankruptcy has been filed. Of course, in the bankruptcy context you will have to be aware of the 90 day preference period. If either an attachment or a perfection has occurred during the preference period, they may be subject to a preference action, which can undo the security interest, lien, attachment or judgment, in the absence of any of the bankruptcy defenses, like new value or ordinary course.

The last thing to consider in terms of priorities is the concept of the PMSI, which stands for purchase money security interest.  The UCC treats the PMSI a little extra special.  The concept of the PMSI is that the secured party enabled the debtor to obtain the collateral.  This is what many of us have done when we have gone out to buy a car with financing.  A special rule applies to the purchase money secured party because they have a 20-day grace period in order to file a UCC-1, and as long as they do that within 20 days of the debtor taking possession of the collateral, then they’re going to get a retroactive effect to the date of attachment and any other secured parties that happen to arise in the meantime get sort of bumped out by that.  In addition, the purchase money rule offers some line-jumping priorities.  So once a commercial entity has a floating lien, that is they’ve granted a security interest in all of their inventory, equipment and accounts now owned, hereafter acquired and forever obtained to some bank, they can still offer a security interest to a secured party that finances the purchase of new inventory or equipment and with a little bit of paperwork, they will get a super priority and jump in line ahead of that prior blanket perfected bank.

A caveat to our discussion of Article 9 of UCC is that while drafters of the UCC had every intent to make the UCC uniform, each jurisdiction that has adopted the UCC may have provided their own modifications to the provisions. Our general discussion does not account for such modifications.  Further, our discussion is of a general nature, the UCC provisions can be extremely complex and detailed, and the devil is in the details as they say.  So, one must refer to the UCC provisions in each jurisdiction.

*I would like to acknowledge and thank Professor Lisa Sparks, Esq., a former attorney with WCS for her contributions to the content of this blog post (she taught the UCC at the University of Baltimore School of Law).

If you have questions regarding the issues discussed in this post, please do not hesitate to contact Michael A. Stover, Esq. ( 410-659-1321/[email protected] ) or any member of the Surety and Fidelity Practice Group .

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Warning: Don’t Ignore Your Customers’ Secured Lenders, You Could be Required to Pay Twice!

New York State’s highest court recently dealt a big win for secured lenders holding accounts receivable as collateral. In Worthy Lending LLC v. New Style Contractors, Inc. , the Court of Appeals of New York held that, pursuant to Article 9 of the Uniform Commercial Code (the “UCC”), a secured party may directly collect on the proceeds of accounts receivable owed to the borrower from third parties (so called “account debtors” in UCC parlance), even if an event of default has not occurred. In so holding, the Court concluded that Section 9-406 of the UCC (which governs the discharge of an account debtor’s liability) applies to secured lending transactions, notwithstanding the provision’s use of the term “assignment”, which the Court determined to be synonymous with a security interest.

Furthermore, the Court determined that a secured lender has an independent cause of action against any account debtor that ignores such lender’s request for direct payment and any account debtor that does not follow such direction will be liable to the lender even if it has already paid its vendor (resulting in double payment).

Case Background:

The Court of Appeals held: “Under UCC 9-406, a security interest is an assignment and the UCC is purposefully structured to permit a debtor to grant creditors security interests in a debtor’s receivables so that the secured creditor can direct account debtors to pay it directly.”

Checkmate Communications LLC and Worthy Lending LLC entered into a Note and Security Agreement whereby Checkmate could borrow up to $3 million from Worthy.  As collateral for the loan, Checkmate granted Worthy a security interest in substantially all of its assets including “all right title and interest of [Checkmate] in and to its (a) accounts…”  “Accounts”, as defined under the UCC, include accounts receivable arising from invoices issued by Checkmate to its customers such as New Style Contractors, Inc. Additionally, the Note and Security Agreement provided Worthy the right to “notify and instruct account debtors” to remit payment directly to Worthy including before any event of default had occurred.

Worthy perfected its security interest by filing a UCC-1 Financing Statement and subsequently notified New Style of its security interest and the collateral assignment of the accounts receivable of New Style. In its notice to New Style, Worthy instructed New Style to remit all payments to Worthy directly instead of to Checkmate. Citing Section 9-406 of the UCC, Worthy also notified New Style that payments made to any party other than Worthy would not discharge New Style’s obligations and liabilities with respect to its accounts receivable.

Following Checkmate’s default on the loan, Worthy accelerated the debt under the Note and demanded repayment. Checkmate filed for bankruptcy protection and Worthy commenced a lawsuit against New Style to collect the receivables owed it to Checkmate. 

New Style sought to defend the claim by asserting that Section 9-607 of the UCC applies only to assignments of accounts and not to security interests in accounts. The Court rejected this argument based on a plain reading of the statute and commentary thereto, and found that Section 9-607(a)(3) expressly states that a secured party may obtain collateral directly from an account debtor and the parties may contractually agree that the secured party may do so without regard to an event of default.

The Court further rejected New Style’s attempt to distinguish a “security interest” from an “assignment” under the UCC citing the definition of security interest in Section 1-201(b)(35) and noting that the definition does not distinguish between the two terms.

Addressing New Style’s concern about potential double payment, the Court indicated that is the consequence imposed by the UCC for failure to heed the notice and request for payment provided by a secured party.

Lessons for Account Debtors:

The ruling in Worthy Lending creates a conundrum for account debtors. If the account debtor ignores a notice from the secured lender and pays its vendor/the borrower instead, such account debtor may nevertheless be liable to the secured lender even if it causes them to pay double.  As stated by the NY Court of Appeals—“[t]hat is the statutory consequence of failing to pay a secured party.”  However, if the account debtor obliges the secured lender, there is a strong chance that the vendor/borrower will no longer provide goods or services to such account debtor since the vendor/borrower did not directly receive payment for the goods or services it delivered. 

If you have received a notice from a purported secured creditor, we suggest that you contact counsel who can assist you to determine whether or not the secured creditor has a perfected lien on your vendor’s receivables and how to respond to such notice. As noted by the Court, an account debtor has certain rights under the UCC to request proof from the secured lender that it possesses a valid assignment and to withhold payment in the interim. Legal counsel can assist you to assert your rights to reduce and discharge your liabilities. 

Lessons for Borrowers

The Court determined that Section 9-607(a)(3) of the UCC establishes the baseline rights of a secured party vis-à-vis the borrower and permits the “the secured party to enforce and collect [from an account debtor] after default or earlier if so agreed .” If you have leverage with your lender and do not want your lender to directly collect from your customers, make sure your security agreements do not give away this right unless an event of default has occurred. If you are planning to take out a loan, you should contact a legal professional to help you navigate the terms and conditions of the loan documents and help you negotiate the best terms with your lender.

If you have any questions about the courts decision or other issues concerning the UCC, please contact Christofer Fattey , James Thoman , Jessica Chue , or any member of the Hodgson Russ Banking and Finance Practice . 

§ 9-312. PERFECTION OF SECURITY INTERESTS IN CHATTEL PAPER, DEPOSIT ACCOUNTS, DOCUMENTS, GOODS COVERED BY DOCUMENTS, INSTRUMENTS, INVESTMENT PROPERTY, LETTER-OF-CREDIT RIGHTS, AND MONEY; PERFECTION BY PERMISSIVE FILING; TEMPORARY PERFECTION WIT

(a) [Perfection by filing permitted.]

A security interest in chattel paper , negotiable documents, instruments , or investment property may be perfected by filing.

(b) [Control or possession of certain collateral.]

Except as otherwise provided in Section 9-315(c) and (d) for proceeds :

(1) a security interest in a deposit account may be perfected only by control under Section 9-314 ;

(2) and except as otherwise provided in Section 9-308(d) , a security interest in a letter-of-credit right may be perfected only by control under Section 9-314 ; and

(3) a security interest in money may be perfected only by the secured party's taking possession under Section 9-313 .

(c) [Goods covered by negotiable document.]

While goods are in the possession of a bailee that has issued a negotiable document covering the goods:

(1) a security interest in the goods may be perfected by perfecting a security interest in the document ; and

(2) a security interest perfected in the document has priority over any security interest that becomes perfected in the goods by another method during that time.

(d) [Goods covered by nonnegotiable document.]

While goods are in the possession of a bailee that has issued a nonnegotiable document covering the goods, a security interest in the goods may be perfected by:

(1) issuance of a document in the name of the secured party ;

(2) the bailee's receipt of notification of the secured party's interest; or

(3) filing as to the goods.

(e) [Temporary perfection: new value.]

A security interest in certificated securities, negotiable documents, or instruments is perfected without filing or the taking of possession or control for a period of 20 days from the time it attaches to the extent that it arises for new value given under an authenticated security agreement .

(f) [Temporary perfection: goods or documents made available to debtor.]

A perfected security interest in a negotiable document or goods in possession of a bailee, other than one that has issued a negotiable document for the goods, remains perfected for 20 days without filing if the secured party makes available to the debtor the goods or documents representing the goods for the purpose of:

(1) ultimate sale or exchange; or

(2) loading, unloading, storing, shipping, transshipping, manufacturing, processing, or otherwise dealing with them in a manner preliminary to their sale or exchange.

(g) [Temporary perfection: delivery of security certificate or instrument to debtor.]

A perfected security interest in a certificated security or instrument remains perfected for 20 days without filing if the secured party delivers the security certificate or instrument to the debtor for the purpose of:

(2) presentation, collection, enforcement, renewal, or registration of transfer.

(h) [Expiration of temporary perfection.]

After the 20-day period specified in subsection (e), (f), or (g) expires, perfection depends upon compliance with this article.