Assignment 23 Maintaining Perfection Through Changes of Name, Identity and Use

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1 Assignment 23 Maintaining Perfection Through Changes of Name, Identity and Use Reference: Understanding Secured Transactions 5.03[C], 8.02 Changes and the Ostensible Ownership Problem A filed UCC-1 is a snapshot of facts as of the date/time of filing, but facts change over time E.g., an initial UCC-1 may be filed under Debtor s name Mary Jones But, if she gets married and begins using the name Mary Williams, 3 rd parties searching under her new legal name might be misled by the absence of filings under the name Mary Williams Possible Solutions to this Problem? Immediate loss of perfection if an initial UCC- 1 becomes seriously misleading due to change (all risk on the filing secured party) SI remains continuously perfected, w/out refiling, after change (all risk on searchers to ferret out true facts through investigation) Temporary perfection (grace period), but secured party must re-file w/in grace period to maintain continuous perfection (balanced risk) Bank has SI in all inventory, accounts, and chattel paper of Bonnie s Boat World, Inc. (including after-acquired), perfected by filed UCC-1 Bank discovers that Bonnie (the president of BBW) has taken one of BBW s boats home, and is using it for personal use Problem 23.1(a) 1

2 Effect of Certain Events on Effectiveness of Financing Statement. Problem 23.1(a). Bank had a perfected SI in the boat when it was on BBW s sales lot. Does it still have a perfected SI now that Bonnie is using the boat for personal use? A. Yes B. No, b/c the boat is now consumer goods and the UCC-1 doesn t cover consumer goods Yes No, b/c the boat is no... (a) [Disposition.] A filed financing statement remains effective with respect to collateral that is sold, exchanged, leased, licensed, or otherwise disposed of and in which a security interest... continues, even if the secured party knows of or consents to the disposition. (b) [Information becoming seriously misleading.] Except as otherwise provided in subsection (c)..., a financing statement is not rendered ineffective if, after the financing statement is filed, the information provided in the financing statement becomes seriously misleading under Section Sale of Collateral: Hypo Problem 23.1(a): Use Change Change creates an ostensible ownership problem To a 3d parties, the boat would appear to be consumer goods (i.e., Bonnie s personal yacht) or perhaps equipment (i.e., the company yacht ) rather than inventory UCC-1 description ( inventory ) thus may mislead searchers But, filed UCC-1 remains effective anyway, so Bank s SI is still perfected [ 9-507(b)] Suppose Bank has a SI in Ford s tractor, perfected by a filed UCC-1 covering the tractor Later, Ford sells the tractor to Baker, without Bank s prior consent Baker will take the tractor subject to Bank s existing SI [ 9-315(a)(1), 9-317(b)], but Sale creates an ostensible ownership problem; 3d parties dealing w/baker (searching for filings under the name Baker ) won t find Bank s UCC-1 covering the tractor (which is filed under the name Ford ) 2

3 Effect of Certain Events on Effectiveness of Financing Statement. Which statement is correct? A. Bank s SI is no longer perfected until Bank files a new UCC-1 listing Buyer as debtor B. Bank s SI is temporarily perfected for 4 months, but that perfection will lapse unless Bank files a new UCC-1 listing Buyer as debtor during that 4- month grace period C. Bank s SI remains perfected even if Bank doesn t file a new UCC-1 Bank s SI is no longer per... Bank s SI is temporarily p... Bank s SI remains perfec... (a) [Disposition.] A filed financing statement remains effective with respect to collateral that is sold, exchanged, leased, licensed, or otherwise disposed of and in which a security interest... continues, even if the secured party knows of or consents to the disposition. (b) [Information becoming seriously misleading.] Except as otherwise provided in subsection (c)..., a financing statement is not rendered ineffective if, after the financing statement is filed, the information provided in the financing statement becomes seriously misleading under Section Problem 23.1(b): Sale Unless Bank authorized this transfer to occur free of its SI, then: Bank s SI continues in the tractor [ 9-315(a)(1)] Bank s filed UCC-1 remains effective to perfect that SI, despite the transfer of the tractor from Ford to Baker [ 9-507(a)] Bank does not have to cure ostensible ownership problem created by transfer of the collateral Perfection Following Sale or Change in Use [ 9-507(a), (b)] What must third party searcher do to protect against the risks posed by 9-507(a), (b)? Searcher must reconstruct chain of title for an asset (all previous owners), and search for filings against each prior owner Searcher must also figure out how debtor may have used the collateral in the past (i.e., whether something that now appears to be equipment was formerly inventory ) 3

4 BBW took a boat from its inventory and traded it to Dealer for a forklift Bank has SI in the forklift (identifiable proceeds of the boat) [ 9-315(a)(2)] But, now there s an ostensible ownership problem: Bank s UCC-1 filing covers inventory, but not equipment! Problem 23.1(c) Problem 23.1(c): After the Debtor completes the exchange and acquires the forklift, which statement is correct? A. Bank s SI in the forklift (as proceeds) is unperfected B. Bank now has a perfected SI, but it will lapse unless Bank amends its UCC-1 to cover the forklift within 20 days after the trade C. Bank will remain perfected, even if it does not amend its UCC-1 to cover the forklift Bank s SI in the forklift (a... Bank now has a perfected... Bank will remain perfect Secured Party s Rights on Disposition of Collateral and in Proceeds. (a) Except as otherwise provided in this article and in Section 2-403(2)... (2) a security interest attaches to any identifiable proceeds of collateral. (b) [Omitted] (c) [Perfection of security interest in proceeds.] A security interest in proceeds is a perfected security interest if the security interest in the original collateral was perfected. (d) [Continuation of perfection.] A perfected security interest in proceeds becomes unperfected on the 21 st day after the security interest attaches to the proceeds unless: 9-315(d) [continued] (1) the following conditions are satisfied: (A) a filed financing statement covers the original collateral; (B) the proceeds are collateral in which a security interest may be perfected by filing in the office in which the financing statement has been filed; and (C) the proceeds are not acquired with cash proceeds; (2) the proceeds are identifiable cash proceeds, or (3) the security interest in proceeds is perfected other than under subsection (c) when the security interest attaches to the proceeds or within 20 days thereafter. 4

5 Perfection of SI in Proceeds If SI in the original collateral was perfected, then SI in proceeds of that collateral is temporarily perfected for 20 days [ 9-315(c), 9-315(d)] Temporary perfection lapses after 20 days, unless Same office rule applies [ 9-315(d)(1)] Proceeds are identifiable cash [ 9-315(d)(2)], or Secured party s original UCC-1 is broad enough to cover the proceeds, or secured party amends its filing to cover the proceeds [ 9-315(d)(3)] Problem 23.1(c) Bank has SI in forklift as identifiable proceeds of boat [ 9-315(a)(2)] SI in forklift is continuously perfected SI in boat was perfected, so SI in forklift is temporarily perfected for 20 days [ 9-315(c)] SI in forklift is continuously perfected thereafter under same office rule [ 9-315(d)(1)(B)] To perfect SI in equipment, you d file your financing statement in the same office as you would file to perfect SI in inventory Same Office Rule: Rationale [Understanding, pp ] The basic idea is that, in certain common financing transactions, a searcher should be able to recognize that a particular type of described collateral will yield a particular type or types of undescribed proceeds. E.g., Debtor s sale of inventory often produces as proceeds accounts, instruments, or chattel paper Thus, a UCC-1 filing vs. inventory should alert a searcher that the secured party might claim SI in accounts or chattel paper as proceeds Does this make sense applied to Problem 23.1(c)? Problem 23.1(c): Same Office Rule While a searcher could reasonably infer that inventory might be sold to produce accounts, instruments, or chattel paper, it is less intuitive for a searcher to appreciate or infer that a boat (inventory) might have been swapped for a forklift (equipment) Nevertheless, the same office rule would apply equally to both situations 5

6 Instead, assume that BBW sold a boat from its inventory, for cash BBW then took that cash and used it to buy a forklift Bank s SI in the forklift (as proceeds) is temporarily perfected [ 9-315(c)] Problem 23.1(d) Problem 23.1(d). Does Bank have to amend its UCC-1 to cover the forklift to maintain its perfected status (after its 20- day temporary perfection period lapses)? A. Yes B. No Yes No Prob. 23.1(d): Cash Phase Rule Bank s SI attaches to the cash proceeds of boat, and then to the forklift as proceeds of the cash [ 9-315(a)(2)] Bank s SI in forklift is initially perfected [ 9-315(c)], but it became unperfected 21 days later, unless Bank amended UCC-1 to describe forklift [ 9-315(d)(3)] Same office rule doesn t apply, because forklift was acquired with cash proceeds Description in initial UCC-1 ( inventory ) doesn t cover forklift (which is equipment ) The Cash Phase Rule Rationale: when 3 rd party asks Debtor where did you get the forklift?, the honest Debtor will respond, I paid cash for it. It s too difficult for 3 rd party to trace where Debtor got the cash from (i.e., to see if cash was proceeds of inventory covered by the initial UCC-1) Thus, if Bank s original UCC-1 didn t cover the forklift, Bank should amend it to cover the forklift 6

7 Effect of Certain Events on Effectiveness of Financing Statement.... Problem 23.2: Name Changes Two years ago, Bank took floating lien on the inventory of South West Appliance Co., Inc. (SWAC), which was perfected by a UCC-1 filing Bank learns that 6 months ago, SWAC changed its legal name to South West General, Inc. What consequence does this change have (if any) for Bank s security interest? Is Bank s security interest still perfected? (c) [Change in debtor s name.] If a debtor so changes its name that a filed financing statement becomes seriously misleading under Section 9-506: (1) the financing statement is effective to perfect a security interest in collateral acquired by the debtor before, or within four months after, the change; and (2) the financing statement is not effective to perfect a security interest in collateral acquired by the debtor more than four months after the change, unless an amendment to the financing statement which renders the financing statement not seriously misleading is filed within four months after the change. Problem 23.2 First step: has the debtor s name change rendered the initial UCC-1 seriously misleading? See Assignment 17: would a search under debtor s new legal name locate the initial UCC-1 filing? Search under South West General, Inc. likely would not return filing under the name South West Appliance Corporation, so this name change renders original UCC-1 seriously misleading As to Bank s SI in SWAC s current inventory, whether it is perfected depends on when SWAC acquired it Bank s SI is still perfected as to inventory acquired by debtor before the name change [ 9-507(c)(1)] Bank s SI is still perfected as to any inventory acquired by debtor during first 4 months after the name change [ 9-507(c)(1)], but Bank s SI is unperfected as to any inventory acquired by debtor more than 4 months after the change (i.e., the past two months) [ 9-507(c)(2)] 7

8 Implications for Bank? If debtor s inventory has turned over w/in past 60 days, then Bank s SI in all of debtor s current inventory would be unperfected! If no other SIs/liens had arisen vs. that inventory, there would have been no problem unperfected SI is still enforceable against debtor! [ 9-201(a)] But, if Debtor had filed for bankruptcy, Trustee could avoid SI in all inventory in which Bank s SI was unperfected [ 9-317(a), BC 544(a)] Problem 23.2 How can Bank can protect vs. this risk? Monitor: confirm Debtor s legal name (on state s corporate records) at least once every 4 months If Bank discovers Debtor has changed its name, Bank can file immediate UCC-1 amendment to reflect name change Security agreement can make it a default for Debtor to change its name w/out prior consent Problem 23.2(b): Name Change Bank also has security interest in a construction crane owned by South West Appliance Co., Inc. (SWAC), which was perfected by a UCC-1 filing Bank now learns that 6 months ago (October 1), SWAC changed its legal name to South West General, Inc. At this moment, what is the status of Bank s SI in the debtor s crane? Problem 23.2(b). Where Debtor changed its name six months ago, and Bank has not amended its UCC-1 filing to reflect the name change, Bank s security interest in the Debtor s crane is A. Still perfected B. Now unperfected Still perfected Now unperfected 8

9 Problem 23.2(b) Bank s SI in the crane remains perfected, even if Bank doesn t amend its UCC-1 to reflect the name change Crane was acquired by debtor more than four months prior to debtor s name change [ 9-507(c)(1)] 4-month period in 9-507(c) is not a grace period of temporary perfection ; as to the crane (which was acquired before change), Bank s SI remains continuously perfected, w/out need to amend Change in Business Structure: Hypo 2010: Alice May opened sandwich shop (as sole proprietor) She granted Bank SI in all of her equipment, including after-acquired, perfected by filing in her name March 2013: Alice incorporated her business and begin operating as Alice s Subs, Inc. What impacts (if any) does this change have on Bank and its SI in the equipment? Alice May (proprietor) and Alice s Subs, Inc. are distinct legal entities Thus, Alice transferred the business assets from herself (as sole proprietor) to Alice s Subs, Inc. (i.e., this is a transfer, not a name change ) For any of Alice s equipment in which Bank had a perfected SI, Bank kept its perfected SI after the transfer to Alice s Subs, Inc. No amendment to Bank s UCC-1 is needed to maintain Bank s perfected status as to that equipment [ 9-315(a)(1), 9-507(a)] Change in Business Structure: Hypo 2010: Alice May opened sandwich shop (as sole proprietor) Bank has SI in all of debtor s equipment, including after-acquired, perfected by filing March 2013: Alice incorporated her business and begin operating as Alice s Subs, Inc. Does change impact Bank s claimed SI in: The original equipment of the sandwich shop? Two new ovens bought after March 2013? 9

10 Alice May (proprietor) and Alice s Subs, Inc. are distinct legal entities; incorporating the business = transfer of assets from herself (as sole proprietor) to Alice s Subs, Inc. (corporation) Thus, this a transfer of assets, not a name change For the equipment in which Bank had a perfected SI, Bank kept its perfected SI after Alice transferred it to Alice s Subs, Inc. [ 9-315(a)(1)] No amendment to Bank s UCC-1 is needed to maintain Bank s perfected status as to that equipment [ 9-507(a)] After incorporating in March 2013, Alice s Subs, Inc. has bought two new sandwich ovens Question: Does Bank have a SI in these ovens (i.e., are they after-acquired equipment covered by Bank s security agreement)? Problem: Alice s Subs, Inc., which bought the ovens, didn t sign the security agreement; Alice did! Is Alice Subs, Inc. a New Debtor? Alice Subs, Inc. is bound by the after-acquired property clause in Bank s security agreement only if it is a new debtor New debtor means a person that becomes bound as debtor under Section 9-203(d) by a security agreement previously entered into by another person. [ 9-102(a)(56)] Attachment and Enforceability of Security Interest.... (d) [When person becomes bound by another person s security agreement.] A person becomes bound as debtor by a security agreement entered into by another person if, by operation of law other than this article or by contract: (1) the security agreement becomes effective to create a security interest in the person s property; or (2) the person becomes generally obligated for the obligations of the other person, including the obligation secured under the security agreement, and acquires or succeeds to all or substantially all of the assets of the other person. 10

11 Attachment and Enforceability of Security Interest.... (e) [Effect of new debtor becoming bound.] If a new debtor becomes bound as debtor by a security agreement entered into by another person: (1) the agreement satisfies [Section 9-203(b)(3)] with respect to existing or after-acquired property of the new debtor to the extent the property is described in the agreement, and (2) another agreement is not necessary to make a security interest in the property enforceable. Is Alice s Subs, Inc. a New Debtor? Alice s Subs, Inc. is a new debtor if It expressly assumed Alice May s specific obligations under the security agreement with Bank [ 9-203(d)(1)], or It generally assumed all of Alice s business liabilities and acquired all of Alice s business assets [ 9-203(d)(2)] New Debtor and Perfection Resolution of Hypo If Alice s Subs, Inc. is a new debtor Bank will have a SI in the new sandwich ovens (under the after-acquired property clause in Alice s security agreement with Bank) [ 9-203(e)(1)] If Alice s Subs, Inc. is not a new debtor Bank will not have a SI in the new sandwich ovens, unless Alice s Subs, Inc. either (a) enters a new security agreement with Bank, or (b) otherwise ratifies the existing security agreement Even if Alice s Subs, Inc. is a new debtor, Bank still has a problem Alice s Subs, Inc. is the new debtor, so Bank s initial UCC-1 (filed under the name Alice May ) is likely seriously misleading under search logic rule Bank had 4 months after incorporation to file a new initial UCC-1 in name of Alice s Subs, Inc. (comparable to name change rule) [ 9-508(b)] Thus, if Alice s Subs, Inc. acquired the 2 ovens more than 4 months ago, even if Bank had a SI in the 2 ovens, it is not perfected! 11