I Stand Corrected - Sort of Maybe You Can Traffic in UCC-1s
Written By: Steven N. Kurtz, Esq., Partner, Levinson Arshonsky Kurtz & Komsky, LLP
This article loosely supplements and ties into the prior article Taking Over the Other Factor’s Deal – It’s More Common Than You Think (published in the Nov/Dec 2015 Issue – Vol 17/No. 16). The inspiration for this article came from a real-life situation. My good friend reached out with a question because her client wanted to take over a prior secured party’s senior position and that creditor did not want to assign its deal documents. For years, and for good reason, lawyers representing secured parties, especially those in the IFA world who routinely take over first-priority lien positions, reflexively always advised clients that when taking over a party’s senior lien position, it must be done by taking an assignment of the deal documents, including the security agreement and the UCC-1. Most people following this advice would then amend the financing statement to reflect the new secured party and amend the assigned agreements as needed. This practice was true even though many of the lawyers advising this method likely knew that this procedure was intellectually flawed.
The reason for this cautious advice was because there are an old line of cases which for some reason decided that secured parties cannot traffic in UCC-1 financing statements. See for example In Re Distano & Moore Associates, Inc., 41 B.R. 935 (N.D. CA 1984). The logic in this line of cases is that the security interest cannot exist independent of the debt, which if assigned requires an assignment of the security agreement and the financing statement. But the reality is that some judge years ago thought that trafficking in UCC-1 financing statements was a bad thing. This logic was accepted and followed. This led to strange situations sometimes. For example, one lender may have a lien against all assets to secure a term promissory note. For those who write or look at security agreements, we tend to pay attention to the actual obligations secured by the collateral. The description of obligations can be limited, such as in my example of the blanket lien securing the obligations under the one term note. Many people have definitions of obligations that state the collateral secures anything and everything under the sun, which allows for all kinds of flexibility.
Getting back to the above example, one who did not want to be accused of trafficking in UCC-1s, wanted to be in a first position, and had a creditor willing to assign its financing documents, had to go through some hoops if the person wanted to convert the first lien deal into a factoring agreement from a note and security agreement. One would likely amend and restate the definition of obligations in the outgoing deal to make sure the collateral secured anything and everything. Then one would amend and restate the deal into the factoring agreement with all kinds of clever things in the documents to make it work. It also got interesting when the second secured party exits the relationship and agrees to transfer the deal to the new factor or lender. There are multiple examples of multiple transfers and then amendments of the deal documents all to avoid trafficking in UCC-1s. However, that is exactly what everyone was doing.
There are two important cases at the trial court level which challenge this notion and allow the transfer of a financing statement coupled with no transfer of the deal documents, and the parties then enter into their own security agreement. The cases are In re Oak Park Financial, 527 B.R. 105 (USBC ED NY 2015) and Interbusiness Bank, N.A. v. First National Bank of Mifflintown, etc, 318 F. Supp2d 230 (USDC M.D. Penn 2004). Both cases were priority disputes between different lenders over a failed borrower. Each case held for the creditor who received an assignment of the first filed UCC-1 and then entered into its own security agreement. In other words, trafficking in UCC-1s.
The Interbusiness Bank case did an excellent job of discussing the logic behind its decision. It began with a discussion of what is required for a security interest. One must have both attachment and perfection. Attachment is simply the agreement that grants the secured party the security interest in the specified collateral (you need an agreement; the debtor must have rights in the collateral and value must be given). Perfection is what the secured party does to let the world know that it has a lien against the collateral and requires compliance with the specified means to perfect, which in most instances is the UCC-1 filed in the correct name in the state where the debtor is registered. The UCC-1 provides notice to the world and puts other creditors on inquiry notice that there is a secured party who holds a security interest. The UCC is a strict race statute. The first to perfect wins no matter what. One can file its financing statement before the security agreement. In fact, the official comments in the UCC discuss two parties with security agreements and financing statements who both lend money, with the person lending first being in the junior position. Well, the person who perfects first wins, even if it advances money later. The Interbusiness Bank court discussed the fact that financing statements can be filed months or even years before the security agreement is executed. The Interbusiness Bank court also recognized that a first in time UCC-1 can be a valuable property right which like any property right, can be transferred freely. The Interbusiness Bank court basically gave a license to traffic in UCC-1s.
We have two differing lines of cases with conflicting results addressing the same problem. One line of cases punishes those who traffic in UCC-1s. Some of these cases are in the appellate court system. The second line of cases recognizes that a UCC-1 is a property right that has value in the financing world and like any other private property, can be transferred. The pro trafficking cases are in the federal court system at the trial court level.
When faced with this problem, one must first look at the jurisdiction where the debtor is located. While the UCC allows you to have your particular state law govern the transaction between you and your factor client/borrower, that is not what determines priority between creditors. According to the UCC choice of law rules, the priority between creditors is determined by the law of the jurisdiction where the debtor is located but can sometimes be the law of the state where the collateral is located, which usually puts you back in the jurisdiction where the debtor is located (See, UCC § 9-301(1) and (2), note that choice of law problems can be confusing!) In addition to choice of law, there also may be other reasons to take over the outgoing creditor’s deal. For example, perhaps there is an intercreditor or subordination agreement that works in your favor, that can be assigned to you, and you don’t want to go back and deal with the creditor on the intercreditor and/or subordination agreement.
The line of cases which allow trafficking in financing statements do a great job of bouncing around Article 9 and get it right. They were also decided after Article 9 was substantially amended in July 2001 and comport with the logic of the current version of Article 9. The anti-trafficking line of cases began with an analysis of common law before the UCC was implemented and then discuss law analyzing older versions of Article 9. The anti-trafficking cases did not have the benefit of the current set of statutes and official comments that have been in place since July 1, 2001, after a major overhaul of Article 9.
From a practical standpoint, one should be able to traffic in UCC-1s, but the case law is unsettled. The answer, in my view, is an amendment to Article 9 which will allow the assignment of financing statements and address the fact that the outgoing financing statement need not be terminated if the deal is paid in full, if it is part of the assignment transaction, and the debtor consents. The official comments can clearly point out that the amendment is to specifically legislate around the cases which do not allow trafficking in financing statements. Until then, one should be cautious and decide the situation on a case-by-case basis.
About Steve Kurtz, Esq.
Steve Kurtz, Esq. is a seasoned attorney with expertise in commercial and bankruptcy litigation, as well as complex commercial finance transactions. He has led numerous high-stakes commercial cases and now divides his time equally between litigation and transactional work, serving a diverse clientele, including financial institutions and fintech lenders.
Beyond his legal practice, Mr. Kurtz has served as a Judge Pro-Tem in Los Angeles County and actively engages in pro bono work. He is also deeply involved in his community, serving as the President of the Calabasas Shul and leading an active lifestyle with his family.
He holds a B.S. in Psychology from San Diego State University and a J.D. from McGeorge School of Law. He is affiliated with several prestigious legal organizations and has been recognized as a "Super Lawyer" by Los Angeles Magazine for multiple years. Additionally, he is a published author and frequent speaker at finance and legal conferences.
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.