Congratulations!  You just executed a contract.  The contract may be a general indemnity agreement (“GIA”), a lease for office space or equipment, or a loan document for financing a construction projection.  Regardless of the reason for the contract, it likely contains a clause titled “Security Interest” with language similar to the following:

 

As security for their obligations hereunder, Person A hereby grants Person B a security interest in the following properties, assets and rights of Person A, wherever located, whether now owned or hereafter acquired or arising, and all proceeds and products thereof: all goods (including inventory, equipment and any accessions thereto), instruments (including promissory notes), documents, accounts, chattel paper, deposit accounts, letter-of-credit rights, securities and all other investment property, supporting obligations, any contract or  contract rights or rights to the payment of money, insurance claims and proceeds, and all general intangibles (the “Collateral”).  This Agreement shall for all purposes constitute a Security Agreement for the benefit of Person B in accordance with the Uniform Commercial Code (“UCC”) and all similar statutes.  Person A hereby irrevocably authorizes Person B, without notice to Person A, in order to perfect the security interest granted herein, to file either: (a) this Agreement or a copy or other reproduction of this Agreement; or (b) any initial financing statements or amendments thereto that indicate the Collateral as all assets of Person A or words of similar effect, as being of an equal or lesser scope or with greater detail and that contain any other information relating to Person A required by Part 5 of Article 9 of the UCC for the jurisdiction where such financing statement or amendment is filed.  Person B may add schedules or other documents to this Agreement as necessary to perfect its rights.  The failure to file or record this Agreement or any financing statement shall not release or excuse any of the obligations of Person A under this Agreement.

Language of this type is intended to give the secured party (i.e., the surety, landlord, or lender) an interest in the debtor’s (i.e., the indemnitor’s, tenant’s, or borrower’s) personal property.  Simply reciting the language, however, does not protect the secured party against competing claims by other parties with an interest in the same property (“Secured Parties”).  As discussed below, more action is required.  Too often the beneficiary of the security interest clause waits until there is a breach of contract or other default before looking into the security interest clause and taking advantage of its protections.  By then, the benefits and protections of a security interest clause may have significantly diminished.

Follow The Rules: The UCC And Revised Article 9

While laws vary from state to state, all states have adopted a version of Revised Article 9 of the Uniform Commercial Code (“UCC”).  Revised Article 9 lays out the ground rules for secured parties, their security interests, and how to enforce security interests.  While some of the same rules apply regardless of the type of property that is subject to the security interest ( e.g., real property, fixtures, or personal property) other rules are dependent on the specific property at issue.  This article examines, more specifically, issues involving security interests in personal property.

 

  • First In Time, First In Line

Under the UCC, secured parties’ rights are often determined by the rule “first in time, first in line.”  This simply means that the first person to perfect his security interest in property is the first person who gets paid from the sale of that property.  Moreover, this is generally true regardless of when the secured party entered into its respective contract with a debtor.  For example, if Secured Party A’s lease was signed on January 1, 2017, and the security interest given in the lease was perfected on April 1, 2017, and Secured Party B’s GIA was signed on February 1, 2017, and the security interest given in the GIA was perfected on March 1, 2017, then Secured Party B would get first “dibs,” or priority, in the debtor’s personal property.

 

Getting first “dibs” in the personal property is important for several reasons.  First, under state law, if you decide to enforce your rights in, for example, the debtor’s construction equipment, the secured party with the “priority” in the construction equipment gets paid first.  If you hold the second “priority” interest in the construction equipment and it does not sell for more than the first “priority” interest’s amount, you get paid nothing, and the security interest gives you no benefit.

 

Second, in the context of bankruptcy proceedings, having the first “dibs” or priority in the debtor’s personal property, in particular cash, gives you extra protection.  For example, if you hold the first priority interest in the debtor’s cash, then your consent will be necessary for the debtor to use the cash to operate its business in the bankruptcy.  Moreover, you could demand additional protection for use of the cash in the form of monthly payments or new collateral in property not otherwise subject to your secured interest.

 

  • Perfecting The Security Interest

So, what does it take to “perfect” a security interest?  The answer varies depending on the property at issue and the state in which the property sits.  Most security interests in personal property are perfected by filing a UCC-1 financing statement with the appropriate agency in the state where the property is located.  Other forms of perfection include having control over the property or taking possession of the property.

 

The UCC-1 financing statement is a short form that requires the secured party to describe the property covered by the security interest.  The level of specificity required in the description will depend in part on the applicable state law and in part on the contract giving rise to the security interest.  For example, secured parties often describe the property covered by a security interest as “all assets or all personal property” of the debtor.

 

  • Once I File A UCC-1 Financing Statement, I Can Sit Back And Relax, Right? Maybe, It Depends On What Happens Next.

                        – The UCC-1 Financing Statement Was Filed More Than 5 Years Ago

Generally, a UCC-1 financing statement is only effective for 5 years from the date of filing.  You can extend your UCC-1 financing statement by filing a UCC-3 continuation statement in the 6 months before the 5 year expiration date.  If you fail to extend your UCC-1 financing statement before the expiration of the 5 years, you may find that you have lost your perfected status.  As a consequence, you may find that your “priority” in the secured property is lost, which means the party second in line may rise to first “dibs” in the collateral.  Whether the party second in line gets first “dibs” after a UCC-1 financing statement expires depends on the nature of that party’s security, i.e., a judgment creditor versus a creditor.

 

                        – The Debtor Moved To A New State.

Despite the slight variations in the UCC provisions adopted by each state, if the debtor moves to a new state, to maintain a perfected security interest in the debtor’s personal property, you will have to file a UCC-1 financing statement in the new debtor’s state of residence.  Most states give the secured party a few months to get a new UCC-1 financing statement filed.

 

                        – The Debtor Changed Its Name.

If the debtor changes his or her name such that the UCC-1 financing statement becomes seriously misleading, i.e., it is unclear who or what the UCC-1 financing statement covers, then you will likely have to file an amendment to update the name of the debtor.  Most states provide the secured party a few months to file an amendment to the UCC-1 financing statement.

 

Filing A Termination Statement When There Is No More Debt

When and whether a secured party is required to file a termination statement depends on the type of property covered by the UCC-1 financing statement, e.g., consumer goods or non-consumer goods.  Once the obligation covered by the security interest is satisfied or terminates, however, the secured party should be prepared to file a termination statement.

 

Conclusion

Don’t wait until the indemnitor, tenant, or debtor defaults under your contract.  Plan in advance for the worst to protect yourself and get the best mileage out of that security interest clause you negotiated for in your contract.