Preferences and the Use of Revised Article 9 to Correct Perfection Defects

Preferences and the Use of Revised Article 9 to Correct Perfection Defects

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Although the rules governing the transition from the prior version of Article 9 to revised Article 9 present a number of challenges to secured creditors wishing to maintain the perfected status of an old-act transaction, the rules also present an opportunity to correct defects in perfection that might otherwise lead to the avoidance of the security interest in a bankruptcy proceeding. Several of the transition rules under revised Article 9 correct old-act perfection defects without requiring any affirmative action by the secured creditor. In other instances, the revised act permits the secured creditor to take steps necessary to correct perfection defects without the consent or assistance of the debtor. While the ability to remedy perfection defects during the transition will be beneficial to secured creditors, the trustee in bankruptcy will be able to avoid any late-perfected security interest if the bankruptcy petition is filed within the relevant 90-day or one-year preference look-back period following perfection.

The Strong-arm Power and Unperfected Security Interests

Under §544(a)(1) of the Bankruptcy Code, the trustee in bankruptcy is given the powers of, and may avoid a transfer voidable by, a judicial lien creditor that obtained a judicial lien on the date of bankruptcy.2 This "hypothetical lien creditor power" gives the estate the status of a judicial lien creditor as of the petition date and allows the trustee to avoid any Article 9 security interest that would be subordinate to the rights of such a lien creditor. Under former Article 9, this meant that the trustee could avoid a security interest that was not yet perfected as of the petition date.3 Revised Article 9 carries this rule forward with a minor modification that establishes the security interest's priority as of the date the financing statement is filed, even if it is not yet technically "perfected."4 As a result of these Article 9 rules, the failure to file an effective financing statement in the proper filing office(s) can result in the security interest being avoided.

Automatically Corrected Defects

Under revised Article 9, a pre-effective date financing statement that is proper under former Article 9 will remain fully effective after the July 1, 2001, revised Article 9 effective date for its normal five-year lifespan, or until June 30, 2006, whichever is earlier.5 Thus, effective old-act financing statements will continue to perfect security interests during the transition period, even if the old-act financing statement would not satisfy the requirements of revised Article 9.6

In addition, the transition rules give full effect to a financing statement that satisfies the requirements of revised Article 9, even if it did not satisfy the requirements of former Article 9.7 The obvious purpose of this provision was to permit a secured creditor to file revised-act financing statements prior to the July 1 effective date. Such financing statements would not become effective until the revision's July 1 effective date.8

However, the rule is not limited to premature revised-act financing statements, but instead extends its protection to any financing statement that satisfies the requirements of revised Article 9, regardless of the reason why the financing statement was filed.9 Since many of the filing rules under revised Article 9 are different from those under former Article 9, and several are more liberal, this rule has the effect of automatically converting some defective old-act financing statements into effective revised-act financing statements at the stroke of midnight on June 30, 2001. In such cases, the unperfected old-act security interest becomes perfected, and the §544 strong-arm power can no longer be used to avoid it.

There are a variety of situations in which the revision will automatically perfect a previously unperfected security interest. One major area where this will occur is in the new place of filing rules under the revision. As discussed in an earlier column, revised Article 9 generally requires that the financing statement be filed only in the state where the debtor is located, rather than the state(s) where the collateral is located.10 If an old-act financing statement covering inventory in several states was erroneously filed only in the state of the debtor's location, then on June 30, 2001, the security interest would have been perfected only as to inventory located in that state. However, as a result of the operation of §9-705(b), on July 1, 2001, the security interest became perfected as to inventory located in all states. In addition, although the former law often required filing at the county level and sometimes required dual filing in both the county and secretary of state's office, the revised act generally requires only a single filing in a statewide office. In such a case, an old-act financing statement filed erroneously in only the secretary of state's office would be ineffective prior to July 1, but would become effective as soon as the revised act became effective.

Automatic perfection can also result from the relaxation of the requirements for a valid financing statement under revised Article 9. For example, the failure to include the debtor's address might render an old-act financing statement ineffective, but would not affect the validity of a financing statement under revised Article 9.11 Thus, on July 1, such a defective financing statement would become fully effective. Similarly, the new collateral description standards could remedy a variety of description errors in old-act financing statements. First, an old-act financing statement that listed "all assets" or "instruments" would become effective. In addition, since the revised act expands the "accounts" category to include a variety of payment rights like license fees, franchise fees, etc., an old-act financing statement that lists "accounts" would begin to perfect a security interest in those assets on July 1. Finally, since the description standards have been relaxed to permit such things a description by computational formula, some descriptions that may have been deficient under former law may be sufficient under revised Article 9.12

Using Revised Article 9 to Correct Perfection Defects

In addition to automatically perfecting some previously unperfected security interests, revised Article 9 makes it much easier for the secured creditor to file or amend a financing statement in order to correct any perfection defects. Under the former law, it was also possible to correct financing statement defects; however, the requirement that the debtor sign the financing statement or amendment meant that the debtor's cooperation was needed.13 Revised Article 9 dispenses with the signature requirement, making it possible for the secured creditor to file or amend a financing statement without the debtor's cooperation, knowledge or consent.

Two different provisions of revised Article 9 yield this result. First, as a general principle, the revised act treats the debtor's authentication of the security agreement as authorization to file a financing statement or an amendment covering the collateral described in the security agreement.14 Thus, after the act's effective date, the secured creditor is authorized to file or amend its financing statements as necessary to perfect its security interest in the collateral described in the underlying security agreement without obtaining the debtor's signature or a separate authorization. In addition, the transition rules provide broad authority to file initial financing statements or continuation statements as necessary "to perfect or continue the perfection of a security interest."15 As explained in the comment to that section, "[T]his section does not require authorization from the debtor."16

Since the revision will cause most secured creditors to review existing loans in order to convert their filings to the new appropriate revised act filing offices, it provides an excellent opportunity to undertake a loan review and correct any perfection problems as part of that conversion process. There are different methods of amending a previous old-act financing statement depending on whether the old-act filing is located in the same office that would be proper under the revised act.

In many cases, the proper filing office under the revised act will be the same office where the old-act financing statement is already on file. In such a case, all that is necessary to do is file an amendment under revised Article 9. No separate authorization or signature of the debtor is required as long as the amendment covers collateral described in the security agreement. Separate authorization from the debtor will be necessary if the secured creditor wishes to use broader language in the financing statement, such as "all assets."

If, however, the revised act's filing rules specify a filing office different from the one in which the old-act financing statement is on file, a different procedure must be used. After the effective date of revised Article 9, an amendment filed in the old-act office will not be effective.17 Instead, the secured creditor must file a new initial financing statement in lieu of a continuation statement (IFSILOACS) in the new appropriate state in order to convert its old-act financing statement into a revised-act financing statement.18 The amendment could be made in either of two ways.19 First, the IFSILOACS could simply include the new information, such as a broader collateral description. Alternatively, the IFSILOACS could be filed first, and then subsequently amended by filing a separate amendment.

Using the Preference Power to Attack Late Perfection

In order for the secured creditor to benefit from the above-described strategies to remedy perfection defects, the debtor must remain out of bankruptcy for the relevant preference look-back period after the security interest becomes perfected. This is because of a special preference rule that treats the perfection date as the date of transfer for security interests that are perfected more than 10 days after the attachment of the security interest.20 Thus, even though the security interest may have been created long before the preference period, the trustee will be able to avoid it if it was perfected during the preference period.21

In the case of security interests that automatically become perfected merely because of changes in revised Article 9, the security interest will be deemed to have been transferred on the act's July 1 effective date. For security interests that are perfected by filing a post-revision financing statement or amendment, the security interest will be deemed to have been transferred on the date the amendment or financing statement is filed. For security interests granted to non-insider creditors, this will generally mean that the security interest can be avoided if the debtor files bankruptcy within 90 days after perfection has been achieved.22 However, if the creditor qualifies as an insider, then the security interest can be avoided if the debtor files bankruptcy within one year after perfection has been achieved.23

Ironically, the one-year look-back period may also apply to a non-insider secured creditor if the loan is guaranteed by an insider. This is a variation of the Deprizio problem,24 part of which was solved by §550(c), which prevents the trustee from seeking an affirmative monetary recovery from a non-insider who receives payment on an insider-guaranteed debt.25 However, since the Code distinguishes between the avoidance of a transfer under §547(b) and the recovery from the transferee of such a transfer under §550, the §550(c) provision does not protect the non-insider when the only relief sought is the avoidance of the transfer.26 In the case of a late-perfected security interest, the avoidance of the lien and its automatic preservation for the estate under §551 is all the relief that the trustee would require. Thus, a one-year look-back period would apply to late-perfected security interests in cases where the debt is guaranteed by an insider.


1 The views expressed herein are Prof. Warner's and do not necessarily reflect the views of the University of Missouri or the law firm of Greenberg Traurig P.C. Return to article

2 See 11 U.S.C. §544(a)(1). Return to article

3 See former §9-301(1)(b). [All citations are to the revised 1999 version of Article 9 of the Uniform Commercial Code, unless otherwise indicated. Citations to the prior version of Article 9 are indicated by the term "former."] An exception to this rule applied to purchase-money security interests, which were given a grace period to file the financing statement. See former §9-301(2). Return to article

4 See 9-317(a)(2). In addition, revised Article 9 provides a 20-day grace period for filing a financing statement for a purchase-money security interest. See §9-317(e). Return to article

5 See §9-705(c). Note that Alabama, Connecticut, Florida and Mississippi have delayed effective dates. See Warner, G. Ray, "Non-uniform Effective Dates and the Transition to Revised Article 9," 20 Am. Bankr. Inst. J. (July/August 2001). However, only Alabama has extended the June 30 "drop-dead" date to Dec. 31, 2006. The impact of these non-uniform effective dates will be ignored for the purposes of the analysis in this column. Return to article

6 See, generally, Warner, G. Ray, "Surviving the Transition to Revised Article 9: The Basics," 20 Am. Bankr. Inst. J. 18 (May 2001). Return to article

7 See §9-705(b). Return to article

8 See §9-701. Return to article

9 See 9-705, cmt. 3. Return to article

10 See Warner, G. Ray, "New Filing Rules Follow the Debtor," 19 Am. Bankr. Inst. J. 16 (March 2000). Return to article

11 Compare former §9-402(1) with §9-502(a). Return to article

12 See §9-108(b). Return to article

13 See former §9-402(1) and (4). Return to article

14 See §9-509(b). Return to article

15 See §9-708(2)(B). Return to article

16 See §9-708, cmt. Return to article

17 See §9-707(b) and cmt. 3. Return to article

18 For an explanation of these procedures, see Warner, G. Ray, "Surviving the Transition to Revised Article 9: Maintaining Perfection," 20 Am. Bankr. Inst. J. 22 (June 2001). Return to article

19 These options are set forth in §9-707(c)(2) and (3). A third option, filing the IFSILOACS and amendment concurrently, is authorized by that section, but presents practical difficulties that should make that option unavailable. See Sigman, Harry C., and Smith, Edwin E., "Revised U.C.C. Article 9's Transition Rules: Insuring a Soft Landing (Part II)," 55 Bus. Law. 1763, 1773, n. 39 (2000). Return to article

20 11 U.S.C. §547(e)(2)(a) and (b). Return to article

21 See Fidelity Financial Services Inc. v. Fink, 522 U.S. 211, 118 S.Ct. 651 (1998). Return to article

22 See 11 U.S.C. §547(b)(4)(A) (setting 90-day look-back period for non-insiders). Return to article

23 See 11 U.S.C. §547(b)(4)(B) (setting a one-year look-back period for insiders). Return to article

24 See In re V.N. Deprizio Construction Co., 874 F.2d 1186 (7th Cir. 1989). Under Deprizio, the transfer would be for the benefit of the insider, and the insider's rights of reimbursement or contribution would make it a creditor, unless those rights were waived. Return to article

25 See 11 U.S.C. §550(c). Return to article

26 In re Williams, 234 B.R. 801, 804-05 (Bankr. D. Ore. 1999). Return to article

Journal Date: 
Saturday, September 1, 2001