Continuing Perfection During Bankruptcy Under Revised Article 9
In many ways, revised Article 9 simplifies life for secured creditors. This is particularly true with respect to most of the act's bankruptcy implications, which have been the subject of these columns. However, one change in the revision will impose new bankruptcy-related duties on secured creditors.
Under current law, the pendency of a bankruptcy or other insolvency proceeding freezes the perfected status of the security interest during the case. If the normal five-year term of the financing statement expires during bankruptcy, the secured creditor is relieved of the duty to continue its financing statement until 60 days after termination of the insolvency proceeding.1
The revised act eliminates this rule.2 Bankruptcy no longer tolls the expiration of the financing statement. Thus, for financing statements expiring after July 1, 2001, secured creditors must file continuation statements before the financing statement lapses, even if the debtor is in bankruptcy.
A Little Background
Under current law, a financing statement perfects a security interest for five years from the date of filing.3 If the secured party wishes to maintain perfection beyond the five-year period, a continuation statement must be filed within six months prior to the expiration of the five-year period.4 If the continuation statement is not filed during the 4 1/2 to 5-year window,5 then the financing statement lapses upon the expiration of the five-year period, and the security interest becomes unperfected.6
However, current Article 9 tolls the expiration of the financing statement during the pendency of a bankruptcy or other insolvency proceeding. Thus, if the security interest is perfected by filing at the time a bankruptcy proceeding is instituted, it remains perfected until, at the earliest, 60 days after termination of the bankruptcy proceeding.7 While current Article 9 permits the secured creditor to file a continuation statement within the usual six-month period if it wishes, the insolvency tolling rule makes it unnecessary for the secured party to take any action in order to maintain perfection during a bankruptcy proceeding.
Initially, it was not clear whether the §362 automatic stay8 prevented the filing of a continuation statement during a bankruptcy case. Several cases addressing this issue drew a distinction between acts to perfect a lien and acts to maintain the perfection of a lien.9 Under this view, a secured creditor wishing to file a continuation statement during a bankruptcy case and within the usual six-month window did not need to first obtain an order lifting the stay.
With the 1994 amendments to the Bankruptcy Code,10 it became clear that the filing of a bankruptcy did not prevent a secured creditor from filing a continuation statement. Following the developing case law, Congress amended §§362(c)(3) and 546(b) to create an express exception to the automatic stay for acts to maintain or continue the perfection of an interest in property.11 As a result of this amendment, one of the primary justifications for the insolvency tolling rule was eliminated.
In addition, the rule created practical problems for the UCC filing offices. Since the filing office was permitted to remove and destroy financing statements one year after lapse,12 non-continued statements could be destroyed after six years. If the filing office was not advised of a pending bankruptcy proceeding, a six-year-old financing statement might be destroyed even though the tolling rule had prevented it from lapsing.13 As a result, the continuation statement filed after termination of the bankruptcy proceeding might refer to a financing statement that no longer existed.
Lapse Waits for No Bankruptcy
The revised act simply deletes the tolling rule. Instead, it requires in all cases that continuation statements be filed "only within six months before the expiration of the five-year period."14 Thus, after the revised act's July 1, 2001, effective date, a secured creditor must file a timely continuation statement if it wishes to maintain perfection and to preserve the priority position established by its initial financing statement.15
What is the effect of a failure to file a timely continuation statement to continue the initial filing? Revised Article 9 modifies the current lapse rule to limit the retroactive effect of the lapse of a financing statement. The revision carries forward the current rule that the security interest becomes unperfected upon lapse.16 Thus, the security interest would be subordinate to a lien creditor who acquires its lien after the lapse and could be avoided under the §544(a)(1) "strong-arm power" in a bankruptcy filed after the lapse.
However, with respect to the retroactive effect of lapse, the revision deletes the words "lien creditor" from the current rule. Thus, if the financing statement lapses, the security interest "is deemed never to have been perfected as against a purchaser of the collateral for value."17 Since the term "purchaser" includes a secured creditor but not a lien creditor, the lapse is retroactive only as to purchasers and secured creditors.18
Since the §544 strong-arm power gives the trustee the status of a lien creditor with respect to the debtor's personal property, the §9-515(c) limitation should prevent the trustee from avoiding a personal property security interest based on a post-petition lapse of perfection. But, since the trustee is given bona fide purchaser status with respect to real property, §9-515(c) may not have that effect with respect to real estate-related interests like fixtures.
However, that result would be inconsistent with the majority view under the case law dealing with post-petition lapse. Although this issue does not arise under the current version of Article 9 because of the insolvency tolling rule, the prior 1962 version of Article 9 did not include an insolvency tolling rule. The cases decided under the 1962 version of Article 9 split, with a few cases holding that the secured creditor's failure to file a continuation statement post-petition destroyed the security interest.19 However, most cases adopted the view that the bankruptcy filing freezes the secured creditor's status as of the petition date.20 Thus, since the trustee's strong-arm power was measured as of the petition date, the post-petition lapse could not be used to avoid a security interest that was properly perfected as of the petition date.
Even though the trustee may not be able to take advantage of a post-petition lapse in perfection, a secured creditor who fails to timely file a continuation statement runs the risk that a third party may prime its lien. Under §9-515(c), a junior secured creditor might be able to take advantage of the post-petition lapse, unless the courts apply the "bankruptcy freeze" logic to all competing parties rather than just the trustee. A more significant threat will come from parties who deal with the debtor post-petition. While the likelihood of this occurring is small in a liquidation case, it is much greater in a reorganization case where the debtor retains the collateral and continues to operate its business.
In such a case, a trustee might even be able to avoid the security interest. For example, in General Electric Credit Corp. v. Nardulli & Sons Inc., 836 F.2d 184, 192 (3d Cir. 1988), the secured creditor failed to re-file a financing statement in the new state when the debtor moved its chief executive office after the chapter 11 plan was confirmed. When the plan failed and the case was converted, the chapter 7 trustee attempted to use the strong-arm power to avoid the security interest. The court rejected that attempt because the petition date of the original chapter 11 case was the relevant date for measuring the strong-arm powers of the trustee in the post-conversion chapter 7 phase of the case. While the secured creditor prevailed in Nardulli, note that the lien could have been avoided by the trustee if, instead of converting to chapter 7, a new bankruptcy had been filed.
No additional states have enacted revised Article 9 since the last issue. Thus, as of early March, only 28 states plus the District of Columbia have adopted revised Article 9. The act has been introduced in six new states, including New York and Pennsylvania, and revision bills are pending in 18 states plus the U.S. Virgin Islands.
1 See current §9-403(2). All citations are to the revised 1999 version of Article 9 of the Uniform Commercial Code, unless otherwise indicated. Citations to the currently applicable 1972 version of Article 9 are indicated by the term "current." Return to article
2 Compare current §9-403(2) with §9-515(d); see, also, §9-515, cmt. 4. Return to article
3 See current §9-403(2). Return to article
4 See §9-403(3). Return to article
5 A continuation statement filed either before or after the six-month window is ineffective. See Hawkland, Lord & Lewis UCC Series §9-403:4, pp. 9-572-73 (Art 9, 1997). Return to article
6 See current §9-403(2) and (3). Current §9-403(2) provides that, "Upon lapse, the security interest becomes unperfected, unless it is perfected without filing. If the security interest becomes unperfected upon lapse, it is deemed to have been unperfected as against a person who became a purchaser or lien creditor before lapse." Since the term "purchaser" includes an Article 9 secured party [see §§1-201(32) and (33)], this provision has the effect of rendering the security interest unperfected both prospectively and retroactively. Return to article
7 See current §9-403(2). If the original five-year period is longer than this 60-day period, then the security interest remains perfected for that longer period. Id. Return to article
8 See 11 U.S.C. §362(a)(4) and (5). Return to article
9 See John Deere Co. v. Alamosa Nat'l Bank, 786 P.2d 505, 506 (Colo. App. 1989); cf. In re Larson, 979 F.2d 625, 627 (8th Cir. 1992) (addendum to mortgage); but, see In re Bond Enterprises Inc., 54 B.R. 366 (Bankr. D. N.M. 1985) (dicta); see, generally, Chobot, John C., Some Bankruptcy Stay Metes and Bounds, 99 Comm. L.J. 301, 310-11 (1994). Return to article
10 See Bankruptcy Reform Act of 1994, §204. Return to article
11 See 11 U.S.C. §§362(c)(3) and 546(b). Return to article
12 See current §9-403(3) and current §9-403, cmt. 2. Return to article
13 See §9-515, cmt. 4. Return to article
14 See §9-515(d). Note that although the five-year rule applies to the great majority of transactions, financing statements filed for public-finance or manufactured-home transactions are effective for 30 years. See §9-515(b). In addition, financing statements filed for transmitting utilities and mortgages filed as fixture filings are effective indefinitely. See §9-515(f) and (g). Return to article
15 Note that if the original financing statement was filed under current Article 9, the revised act's transition rules may impose special requirements on a continuation statement filed under revised Article 9. For example, the revised act requires that most financing statements be filed in the debtor's state of incorporation, whereas current law requires that the financing statements be filed in the state where either the collateral or the debtor's chief executive office is located. Compare current §9-103(a) and (c) with §§9-301 and 9-307(b). Thus, the continuation statement may need to be filed in a state different from the state in which the original financing statement was filed. In such cases, the revised act requires the filing in the new state of an "initial financing statement in lieu of a continuation statement." See §§9-705(d) and 9-706(a). This record must identify the pre-revision financing statement and indicate that it remains effective. Unlike a normal continuation statement, such a statement may be filed at any time during the five-year life of the original financing statement. See §9-706(b) and (c). Return to article
16 Section 9-515(c) states, in part, "Upon lapse, a financing statement ceases to be effective, and any security interest or agricultural lien that was perfected by the financing statement becomes unperfected..." Return to article
17 §9-515(c). Return to article
18 Note that the "for value" restriction will not exclude any Article 9 secured creditors because secured creditors give value by definition when they obtain a security interest. See §1-201(44)(b). Return to article
19 See In re Radcliff Door Co. Inc., 17 B.R. 153, 156 (Bankr. W.D. Ky. 1982). Return to article
20 See, e.g., Matter of Chaseley's Foods Inc., 726 F.2d 303, 304, 308 (7th Cir. 1983); In re Catamount Dyers Inc., 50 B.R. 788, 790 (Bankr. D. Vt. 1985) (citing cases); cf. In re Halmar Distribs. Inc., 968 F.2d 121, 127-28 (1st Cir. 1992) (bankruptcy freezes matters so post-petition interstate moves do not require refiling under §9-103). Return to article