You're not done yet: "where, oh, where" continues 'til 2006

RMA Journal, The, May, 2004 by Chalmer William West, Jr.

Life will be simpler ... maybe ... someday. Until then, in the search phase of transactions, a prospective lender must avoid the transition period pitfalls of Article 9.

With the adoption in each state legislature of revised Article 9 of the Uniform Commercial Code, life for commercial lenders taking perfected security interests seems to have been simplified. The simplification, however, will be somewhat illusory until July 1, 2006. That date marks the end of the transition period provided for a total filing shift to the new Article 9 provisions. Until that date, prospective secured lenders will find their hoped-for first lien positions at risk unless they are able to discover existing liens filed prior to July 1, 2001.

There are many notorious oxymorons in the English language, including "jumbo shrimp," "working vacation," "plastic glasses," and "alone together." As notorious as all of the above, at least until July 1, 2001, was "Uniform Commercial Code." For although the UCC had been around in one version or other for nearly four decades, it had never been truly uniform.

Article 9 of the UCC was particularly nonuniform, especially in the requirements for perfecting a security interest in personal property collateral, such as accounts, inventory, equipment, and farm products, where a public record filing was required. The UCC is not and never has been a federal law. It was introduced to the various state legislatures, which could either reject it, pass it without change, or pass it with little or considerable tweaking as determined to be in the best interest of their constituents.

With regard to the Article 9 filing requirements, most states elected to tweak them considerably. Actually, versions of Article 9 enacted prior to the most recent version encouraged nonuniformity by providing alternative filing provisions. Even the UCC commissioners could not agree on uniform filing requirements.

Some states required central filing for accounts, inventory, and equipment, but local (county) filings for farm products. Where farm product collateral was included, some states permitted a single filing in the county of the debtor's residence, while others required filings in each county where the farm products were being produced. The rule in some states for filings against accounts, inventory, and equipment required a central filing and, if the debtor was doing business in only one county of the state, an additional filing in that county.

Where the collateral consisted of accounts, the law to follow was that of the state where the principal office of the debtor was located. If the debtor had more than one office, the debtor was required to declare which was its principal office. For inventory, equipment, and farm products, the law to follow was that of the state where the collateral was located.

On July 1, 2001, with the exception of a couple of states that came on board between that date and January 1, 2002, all of that changed. New Article 9 provides that the law to follow for deciding where to file to perfect a security interest is that of the state where the debtor is located.

Under the new law a debtor required to register with a state to be a legally recognized entity is located in the state where that registration was done. A debtor not required to register with a state to exist is located in the state where the debtor resides or is doing business. When the debtor location has been determined, a single filing is required to perfect a security interest in accounts, inventory, equipment, and farm products in a central location in that state.

However, during the transition period, any security interest that was properly perfected by filing prior to July 1, 2001, will continue to be effective unless it lapses before July 1, 2006, the end of the transition period. So a prospective secured lender during this transition period will have to be aware of the new filing rules for perfection of any security interest taken, but will also have to live by the old roles when ordering searches to determine whether any effective prior filings exist against the same collateral. The following is an example of how that might work.

Company A, a Nevada corporation, has its principal office in Colorado. It also has a manufacturing facility in Colorado and warehouses inventory in Colorado, Utah, and Wyoming. The company has applied to Bank X for a revolving credit line. Bank X is willing to make the loan but wants a perfected first lien on the company's accounts, equipment, and inventory.

The bank knows that under the existing law the company is located in Nevada because that is where it registered to establish its existence. Therefore, any filing done by the bank would have to follow that law, which would require that a financing statement be filed centrally in Nevada. The bank should also search there to determine whether any filing had been done by a prior lender.

However, this search alone will nut do. Until the end of the transition period, due diligence requires more. Prior to July 1, 2001, the law in Colorado, since that is the state where the principal office of the company was located, would apply, It would have required that a financing statement against accounts be included in the Secretary of State's central index. A filing against the company's equipment would have been required in the same index since the equipment was located in Colorado and the filing is subject to Colorado law.