The July 1, 2001, effective date of revised Article 9 is just around the corner. The changeover to a new legal regime is never an easy process; the Article 9 transition will be no exception. As discussed in previous columns, the revision changes many of the rules that govern the creation, perfection and enforcement of security interests in personal property. How will those changes affect secured transactions entered into before the revision's effective date?

Revised Article 9 attempts to answer this question in a mind-numbing series of transition rules. See §§9-701-9-709.² These rules assume that all states will have adopted the revision prior to its effective date, and thus all states will switch over to the new regime simultaneously on July 1.³ The transition would be difficult enough if that occurred. Unfortunately, it appears that a substantial minority of states will not meet the target date. The revised act makes no attempt to explain what will happen if one or more states fail to adopt the revision on time,⁴ and I am not brave or foolish enough to attempt that feat here—at least not yet. So let's just pretend that every state adopts the revision, and let's see how the transition is supposed to work. As you'll see, even with that simplifying assumption, there is only enough room in one column to discuss the most basic rules.

The Easy Stuff

This month's column will deal with the effects of the revision on an existing security interest that was taken under current Article 9 in an asset that was in existence prior to the effective date of the revision. Next month, we will look at how the rules work in more complicated situations and how to continue pre-revision financing statements.

If the security interest was properly attached and perfected under current Article 9, there is little to worry about early on. The steps for attachment (i.e., enforceability against the debtor) are similar enough so that most security interests that properly attached under current law should be properly attached under the revision.

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One of the revision's major reforms is that it changes the proper state for filing most financing statements to the state of the debtor's location.

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The principal exceptions involve consumer goods and consumer investment property. Under the revision, a security agreement description by UCC type alone (e.g., "all consumer goods" or "all securities accounts") is not sufficient for attachment for these types of assets in a consumer transaction.⁵ Instead, a more specific description is required, such as "all TVs" or "Merrill Lynch securities account." If a security interest under an agreement using the "type" description has attached and is perfected under current law, it remains enforceable and perfected⁶ for one year following the effective date of revised Article 9.⁷ If, during that year, the debtor authenticates a new security agreement with a proper collateral description, the security interest remains enforceable and perfected after the one-year period. If, on the other hand, no action is taken during the one-year grace period, the security interest becomes unenforceable at the end of the year.

An "attachment" problem might also arise if the security agreement uses the Article 9 terminology—such as "accounts"—to describe the collateral because some of the UCC categories of collateral have been redefined. For example, license fees currently qualify as "general intangibles," but will be considered "accounts" under the revision.⁸ If the security agreement refers to "license fees," there will be no problem because any description that would have been adequate under current Article 9 should be an adequate description under revised Article 9.⁹ However, if the security agreement refers merely to "general intangibles," will its scope change on July 1? The revision does not answer this question, but instead treats it as one of contract interpretation. Presumably the courts will conclude that the parties meant to refer to items defined as "general intangibles" at the time of the execution of the agreement.¹⁰ However, careful lawyers will clean up the documentation to avoid this ambiguity because memories fade and courts several years hence may not get the answer right.

Perfection by Possession

What about perfection? Well, that depends on how the transaction was perfected under current law. The easiest case is perfection by possession. This method remains effective as a method of perfection under revised Article 9,¹¹ so merely by maintaining possession (which must be done anyway under current law) the security interest will remain perfected after July 1.¹²

The principal exception involves the situation where the collateral is in the possession of a bailee. Under current law, perfection can be achieved merely by giving notice of the security interest to the bailee.¹³ However, the revision adds a requirement that the bailee must authenticate an acknowledgement that it holds the collateral for the secured party's benefit.¹⁴ Under the transition rules, a pre-revision security interest properly perfected by giving notice to the bailee remains perfected for one year following the effective date.¹⁵ If the secured party obtains the necessary authenticated acknowledgement from the bailee during that one-year grace period, then the security interest remains continuously perfected after the one-year period. If, on the other hand, no acknowledgement is obtained, then perfection lapses at the end of the year.

Perfection by Filing

One of the revision's major reforms is that it changes the proper state for filing most financing statements to the state of the debtor's location.¹⁶ Thus, financing statements filed under current law may be located in a state that would not be the proper filing state under the revision. In addition, for some types of collateral, the revision eliminates the need for local filing at the county level and substitutes filing in a state-wide office. What is the effect of the revision on proper pre-revision filings that are located in offices that would not be the proper filing offices under the revision?

If the security interest was properly perfected by filing under current law, then nothing needs to be done until the earlier of June 30, 2006, or the date when the filing would have lapsed under current law.¹⁷ Since financing statements generally lapse and must be continued after five years, the June 30, 2006, drop-dead date would have coincided with the longest possible effective pre-revision financing statement if all states had converted to the revision simultaneously on July 1, 2001. As it is, the drop-dead date may spell an earlier-than-usual death for any financing statement filed after July 1, 2001, in a state that does not adopt the revision in time.

This provision helps the existing pre-revision secured party because it does not need to take action to remain perfected for up to five years. However, as a result, a security interest could be validly perfected either by a financing statement filed under the revision or by a financing statement filed under the current law for up to five years following July 1, 2001 (or longer if any late-adopting state modifies the drop-dead date). This means that a search of the filing system during the first five years must cover both the old and the new filing locations.

Priority and Foreclosure

But what about the new priority rules? Could they affect the lien? Well, maybe. The current law's priority rules will govern disputes between any parties whose relative priority was established before the revision's effective date.¹⁸ Thus, the revision will have no impact on the relative priority between two secured creditors, both of whom assert security interests perfected pre-revision.

However, if at least one of the claimants bases its claim of priority on post-effective date actions, then the revision's priority rules will apply.¹⁹ In most cases, this will not create problems for a security interest perfected prior to the revision's effective date. However, there are a few cases where the problems could be devastating.

An area where this problem may arise involves proceeds. Under current law, if the security interest in inventory is perfected, the secured party automatically has a perfected security interest in any identifiable cash proceeds generated by the sale of inventory. If those proceeds are deposited into the debtor's bank account, the "proceeds" security interest will have priority over any set-off rights of the depository bank (and there will be no competing secured party with a valid security interest in those funds).

However, under revised Article 9, a competing lender could obtain a security interest in the deposit account and could perfect by "control."²⁰ Since that lien arises and the perfection step of "control" occurs post-the effective date, the revision's priority rules will apply to any dispute between the proceeds security interest and the control security interest—even as to proceeds that came into existence prior to the effective date. Under the revision, the new control security interest will have priority over a perfected security interest in proceeds.²¹ In addition, under the revision, the depository bank's set-off and recoupment rights have priority over a perfected security interest in proceeds.²² Thus, if the bank's set-off or recoupment right arises after the effective date, the revision's priority rules will apply and will subordinate the proceeds security interest.

What about the rights and duties of the secured party? Will they change on July 1, 2001? Yes—a repossession or an Article 9 sale occurring on July 2, 2001, must comply with the new rules, even though the security agreement was entered into and the default occurred prior to the revision's effective date.²³ Although there are some new rules that may not be viewed favorably by the secured creditor (such as the new notice requirements in consumer cases), most of the changes in the default and foreclosure rules enhance the secured creditor's rights (e.g., the new partial strict foreclosure option and the elimination of the absolute bar to deficiencies in cases of non-compliance with the rules).²⁴

Enactment Update

Four new states have adopted revised Article 9 since the last issue. They are Idaho, Mississippi, New Mexico and Wyoming. Thus, as of early April, only 32 states plus the District of Columbia had adopted revised Article 9. The act has been introduced in four new states—Florida, Louisiana, Ohio and South Carolina. Thus, revision bills are pending in 18 states plus the U.S. Virgin Islands.

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Footnotes

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

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

³ Section 9-701 attempts to establish a uniform national effective date of July 1, 2001. Return to article

The Official Comment to §9-701 states, "If former Article 9 is in effect in some jurisdictions, and [revised Article 9] is in effect in others, horrendous complications may arise." Return to article

⁵ See §9-108(e). Note that current law in some states already prohibits the use of a generic "consumer goods" description. Return to article

⁶ Perfection could lapse earlier if, for example, the pre-revision financing statement expires during the one-year period. Return to article

⁷ See §9-703(b) and cmt. 2. Return to article

⁸ Compare current §9-106 with §9-102(a)(2). Return to article

⁹ See §9-108(a) and (b). Return to article

¹⁰ See §9-703 cmt. 3. Return to article

¹¹ See §9-313(a). Return to article

¹² In addition, the relaxed attachment rules continue to apply to possessory security interest, so an oral agreement remains sufficient to create such a security interest. As a result, the pledgee need do nothing to retain its perfected security interest. Return to article

¹³ See current §9-305. Return to article

¹⁴ See §9-313(c) and cmt. 4. Return to article

¹⁵ See §9-703(b) and cmt. 2, ex. 2. Return to article

¹⁶ See, generally, Warner, G. Ray, "Secured Transactions: New Filing Rules Follow the Debtor," 19 ABIJournal 16 (March 2000). Return to article

¹⁷ See §9-705(c). Return to article

¹⁸ See §9-709(a). Return to article

¹⁹ See §9-709 cmt. 1, ex. 3. Return to article

²⁰ See Warner, G. Ray, "Deposit Accounts as Collateral Under Revised Article 9," 19 ABIJournal 18 (August 2000). Return to article

²¹ See §9-327(1) and cmt. 3. Return to article

²² See §9-340. Return to article

²³ See §9-702(a) and cmt. 1. Return to article

²⁴ See, generally, Warner, G. Ray, "Default and Foreclosure Under Revised Article 9," 19 ABI Journal 20 (May 2000). Return to article