Due Diligence: The Importance of Running a Nationwide Search and Expanding Debtor Name Variations. Or, How to Plan a Proper Family Reunion.

Written by: Jason M. Medley, Esq., Partner, Spencer Fane LLP

We all know that you must use the name of the debtor on your UCC1 verbatim as it appears in the organic record with the state of formation, and you must file the UCC1 in that particular state (or Washington, D.C. for foreign debtors). However, the same search logic should not apply to running due diligence. On the front end, focusing on the exact name and only the particular state of formation is too myopic. Think of it this way: when you're planning a family reunion, you don't just invite the relatives who live in your hometown and have your same last name (you have in-laws, after all, and thankfully they live out of state). It is important that when conducting due diligence you (a) run a nationwide search, and (b) run duplicate searches using name variations to expand your search.

For example, many debtors may have registered to transact business in a different state, or they simply conduct business nationwide. It is not uncommon for a state labor department or state taxing authority, and even the IRS, to file (incorrectly) a UCC lien in that state, instead of the state of the debtor's formation. Also, it is not uncommon for a judgment lien or even a standard creditor's UCC1 lien, to be filed in the wrong state (e.g., the state where the judgment was obtained, or the state where the debtor is headquartered). I have found many creditors (even a few MCA's) that have simply just filed in the wrong state by mistake.  Like that idiot cousin that is always at the wrong place at the wrong time wreaking havoc (who you still invite to the family reunion nonetheless), a misfiled lien is still important information for your due diligence assessment, and if you run a lien search only in the state of formation, you will miss this important data. 

Similarly, some creditors will file a UCC1 using the incorrect name of the debtor. We all know how fatal that can be, yet it happens all the time. Even though the other creditor's lien might be invalid, you can rest assured they'll argue otherwise; they will have no choice but to fight to keep their lien position. You don't want to have to pay legal fees to fight about whether or not their lien was misleading. Running a duplicate lien search using a couple of variants of the debtor's name (e.g., without the ", Inc.", dropping the plural "s" at the end) will help unearth these competing liens. It's like checking the reunion RSVP list for your uncle, "Bob Smith," "Robert Smith," and "R. J. Smith", because you know it's all the same guy, but he never fills out forms consistently and you really want to know if he’s coming to the party. Again, even if they are rendered invalid and the other creditor is deemed to be unperfected, knowledge of their mere existence is critical for your due diligence analysis. It may produce redundant information, but it's worth it. It only adds negligible time to your search efforts.

When it comes to litigation, it is important to remember that some courts (mostly the smaller courts in rural jurisdictions) don't have the best online filing systems and pending litigation may not be accurately reported, and documents may not be readily available for download. Prospects don't always tell the truth about their litigation history, or perhaps they've forgotten (the institutional memory of the company may have failed), or they may have not secured a satisfaction of judgment (similar to a release of lien) when paying off a judgment. Running a duplicate search (e.g., using your filing vendor's litigation search feature, plus another database like PACER, Westlaw or LexisNexis) will help ensure accuracy. And even though your prospect may appear to be geographically limited, the world has gotten a lot smaller, and plaintiffs can attempt to sue in their own jurisdiction for a variety of reasons. This means that limiting your litigation search to the prospect's home state will miss a lawsuit pending in another state. And using a few variants of your prospect's legal name is important because a plaintiff may accidentally get the name slightly wrong or sue only the assumed name ("DBA") of your prospect. At family reunions, drama has a way of traveling.  Similarly, a dispute that started in one state can follow your prospect to another, and you need to know about all of it.

On a side note, I get asked often how to evaluate pending litigation. There is no exact science to this. Essentially, you are trying to ascertain if the case is simply a typical, not-too-terribly-unexpected business dispute brought by the parties in good faith, and can it be managed through insurance coverage and/or is it something that would not render your prospect economically unviable (either through defense costs or a potential judgment based on the amount sought), then you should not necessarily be scared off. If the financial stakes are high, or if the case involves (somewhat believable) allegations of fraud or if their existence is at stake (e.g., a patent dispute that if lost would render them irrelevant as a going concern), then you may want to think twice before approving the deal. Regardless, you will want to monitor the case and consider getting consent from your prospect's lawyer to share information (subject to attorney-client privilege limitations). There will be certain critical dates to calendar, such as the deadline to file a motion for summary judgment or the trial date itself. Remember, a judgment is by itself not a judgment lien, but reducing a judgment to a judgment lien is easy to do, so don't rely on the difference in making a due diligence decision; treat the judgment as basically the same. Judgment liens are not always found in the UCC database (in fact, some courts have held that you can't create a judgment lien by recording a UCC1). Instead, they are perfected by levying or abstracting the judgment. It's not as clear as recording a UCC1, so do not rely on just the UCC records for determining if a judgment lien exists; it is safer to just treat a judgment like a judgment lien when you are underwriting a deal. Remember too, that a subsequent judgment lien won't prime you, but it can wreak great havoc nonetheless (not too unlike a subordinate MCA trying to collect money). Note, however, that a judgment lien can prime future advances made after the 45th day following the lien (similar to the IRS 45-day rule), but that applies to loans (or over-advances? Or loan addendums to your factoring agreements?) and does not apply to factoring deals. Regardless, if you become aware of a judgment rendered against your client, you should confer with your attorney immediately.

Another good tip is to remember to not only check for good standing with the secretary of state, but also with the equivalent state taxing authority such as the state comptroller (or controller). The prospect can be in good standing with the secretary of state but not the comptroller. It is worthy to take note of the delinquency and be mindful that it is only a matter of time before the left hand (the comptroller) tells the right hand (the secretary of state) to initiate revocation warning notices to the prospect and eventually revoke their charter. These delinquencies are often easy to fix, but you want to catch them at the comptroller level before they become a bigger problem with the secretary of state. Think of it as making sure all the branches of the family tree are on speaking terms.  Because when they're not, trouble follows.

Lastly, I like to remind my clients to periodically perform what I lovingly refer to as "the due diligence family reunion" by re-running a lien search (as well as standing and litigation, if you have the manpower). Like any family reunion, you need to check back in periodically to see who's shown up uninvited (new liens), who's changed their name (corporate amendments), or who's moved to a new state (re-domestications). If you are not using Tax Guard or a UCC filing vendor, you won't always get notice of a federal tax lien (45-day rule) or notice of a junior lien (like an MCA), which would necessitate that you consider ceasing to fund. And you may not get notice that your client has changed jurisdictions or changed its name (you have 4 months to amend your UCC1 accordingly, to reflect the new name or re-file in the new state). Good standing with the state/comptroller is usually an annual issue, but the other items can change things quickly. Due diligence is not a once and done sort of thing.  Much like a family reunion, you can't just host it once and assume everyone stays frozen in time. People (and your prospect) change without warning.  Some people even die (if the owner of your client dies, you need to know that and respond accordingly).  Conduct due diligence upfront and then revisit it periodically (perhaps every 4-6 months, depending on the amount of labor you can devote to it, but that's easy for a lawyer to say). You should definitely re-run it at renewal, with a significant modification, during a forbearance or workout, or if you get wind that your client is in economic trouble or you start experiencing payment over notice issues or any other warning sign.

Running a nationwide search and using a variant of your prospect's name may yield more search results that you have to wade through and likely dismiss, and revisiting due diligence periodically can add time and expense to your budget, but knowledge is power, and in this case, it can help you ensure that you have all the data you need to make a proper valuation of your potential client, on the front end and during the life of the deal. After all, the best family reunions aren't necessarily the ones where everyone actually shows up.  They're the ones where you know exactly who's coming so you can prepare accordingly. You want to arrive armed with knowledge about Uncle Federal Tax Lien's bad habits, Cousin Judgment's tendency to start fights, and that Subordinate MCA In-Law who always shows up drunk and grabbing at what isn't his. That way, you, the senior secured creditor, the only sane one in the bunch, can sit alone at the adult table with your proper documentation and your exclusive, perfected lien, and watch the chaos unfold from a safe distance. Knowledge isn't just power.  It's the difference between walking into a disaster and walking in prepared, with your eyes wide open, your priority position secured, and a clear view of exactly which relatives have already ruined Thanksgiving and who's likely to ruin Christmas.

About Jason M. Medley, Partner, Spencer Fane LLP

Jason Medley helps banks and other financial institutions structure transactions in a manner that enables them to be efficiently closed, allowing for key stakeholders to maximize benefits and avoid unnecessary delays or costs. His work fully encompasses all aspects of contract negotiations, workouts, intercreditor relations, and secured party collections.

Jason represents banks, factoring companies (purchase and sale of accounts receivable), and real estate entities in a wide variety of transactional matters from due diligence to contract negotiations, workouts, intercreditor relations, and secured party collections. He has almost 25 years of extensive experience in asset-based loan (ABL) financing and uniquely serves as a preferred attorney for the International Factoring Association, which assists with providing information, training, purchasing power, and resources to the Factoring community.

In addition, Jason also represents businesses in corporate governance and general matters, including entity formation, contracts, leasing, mergers, and acquisitions. He is a frequent speaker at professional conferences and area civic groups on trend topics in the financial services industry in addition to providing written thought leadership.

The views expressed in the Commercial Factor website are those of the authors and do not necessarily represent the views of, and should not be attributed to, the International Factoring Association.