Accounts-receivable secured lending: looking over your shoulder

RMA Journal, The, July-August, 2004 by Mark Zoeller

For registered entities, the Revised UCC Article 9 requires that the filing use the correct legal name. You will find the correct legal name by getting a copy of the actual formation documents and all its amendments. If, however, you verify the legal name merely by getting a database printout from the state, the name you find might be a trade name rather than the full legal name.

Different banks have different philosophies about A/R loan agreements. Legal opinions I am aware of recommend that the loan agreement not mix "demand" language with financial covenants because the mix might be legally confusing. If the bank wants to make demand but the borrower is within its financial covenants, which approach would win? I do not pretend to know the answer, but I do know that most states have a legal principle that if the language is ambiguous the courts will interpret the language against the drafter of the document. On occasion I do see a mix of demand language and financial covenants. You can work that out with your lawyers.

Covenants, though, should mean something. Set them too tight and the borrower might be in constant default. Set them too loose and they do not help control the risk. Some banks set financial covenants so loose that the borrower could not violate them except in extreme circumstances. Covenants must be tighter than that. I have seen several instances where the loan officer neither waived nor enforced a covenant violation. If you do neither, you may be in danger of not being able to enforce that covenant in the future.

Some loan officers seem oblivious to super-priority liens. Construction-contract bonding is one such priority. I know of three super-priority agricultural liens: the Packers and Stockyard Act, the Poultry Producer Financial Protection Act, and the Perishable Agricultural Commodity Act. These liens carry through to A/R and proceeds. My employing bank in the 1970s had a close encounter with the Packers and Stockyard Act. The result was not in the bank's favor. The IRS, too, can file a lien on A/R. Its lien is a super-priority on A/R generated more than 45 days from the filing of the lien. The IRS seems to be less aggressive than it once was in filing liens, but it occasionally still files liens. The IRS follows federal law, not the UCC, in filing liens. This can create conflict with UCC liens because the IRS lien may have a name that is slightly different from the true legal name, and federal law states that the filing is to be in the state of the administrative office. The UCC was not designed to easily deal with IRS liens. There are ways to search for IRS liens, but here are two strategies for helping to cope with the problem:

1. Search for UCC filings using the name and location on the borrower's tax return.

2. Have the borrower sign IRS Form 8821 and send it to the IRS. This document entitles the bank not only to receive copies of the borrower's tax returns but copies of any communication the IRS has with the borrower.

These are not the only super-priorities out there. Another federal law that might affect collateral, for example, is ERISA, where the pension trust has a super-priority if it does not receive the pension payments.