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Using the Strong-arm Power to Attack Name Errors Under Revised Article 9

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As discussed in earlier columns, most of the changes introduced by the Article 9 revision will make it more difficult for security interests to be avoided in bankruptcy. However, one area where that is not the case is the new standard for measuring whether a financing statement sufficiently lists the name of the debtor. The new legal standard, coupled with strict search logic standards being adopted by filing offices, should make it much easier to challenge the perfection of a security interest on the basis of minor errors in the debtor's name.

The Strong-arm Power and Financing Statement Errors

The §544(a)(1) "strong-arm" power2 gives the trustee in bankruptcy 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 revised Article 9, as under prior law, this means that the trustee can avoid a security interest that has not yet been perfected as of the petition date.3 Since most security interests are perfected by filing a financing statement, the standards for measuring compliance with the filing requirements will be critical in determining whether a security interest can be avoided.

Revised Article 9 greatly reduces the probability of making fatal financing statement errors both by reducing the number of filings required4 and by reducing the types of errors that can render the financing statement ineffective.5 With respect to the contents of the financing statement, only errors in the debtor's name, secured party's name or indication of the collateral can render the financing statement ineffective as to lien creditors—and thus trustees—in bankruptcy.6

Of these three items, only the debtor's name is likely to provide much opportunity for lien avoidance. Since revised Article 9 greatly relaxes the collateral indication requirement and even permits "all assets" filings, it will become much more difficult for trustees to avoid security interests on the basis of collateral description errors.7

The trustee's ability to avoid security interests on the basis of financing statement errors is further reduced by §9-506(a). Under that section, an error does not render the security interest unperfected unless the error "make[s] the financing statement seriously misleading."8 Official Comment 2 interprets this standard to remove errors involving the secured party's name from the list of potentially fatal errors. As stated in the comment, "Inasmuch as searches are not conducted under the secured party's name...an error in the name of the secured party or its representative will not be seriously misleading."9 Thus, the principal focus of strong-arm challenges to financing statements will be the debtor's name requirement.

The Correct Name

In general, revised Article 9 provides clearer rules for determining the correct name to use for a debtor on a financing statement. For registered organizations such as corporations, limited partnerships and limited-liability companies, the financing statement must list the name of the debtor as it appears in the public records of the jurisdiction where the debtor was organized (i.e., the incorporation records of the state of incorporation).10 For human debtors and most unregistered organizations, the financing statement must list the "individual or organizational name" of the debtor.11

While these rules make it very easy to determine the correct name for registered organizations, revised Article 9 makes no attempt to resolve the many issues that can arise with respect to human names. For example, the revision does not indicate whether the full legal name is required or whether a nickname or widely used alias is sufficient. While the old manual search systems could accommodate some variation in human names, the modern computerized search logic used by the filing offices has little tolerance for variations. Thus, courts interpreting the revision will be forced to resolve these issues in light of the limitations of computerized filing systems.

The "Seriously Misleading" Standard

As noted above, an error in the debtor's name is not fatal unless it makes the financing statement seriously misleading. Under prior law, the courts determined whether an error was seriously misleading by asking whether a hypothetical "reasonably diligent searcher" could discover the erroneous filing. Under this standard, human judgment was relevant, and being close was often good enough. For name errors, the revision replaces this reasonableness standard with a precise standard based on the computerized search logic used by the relevant filing office. Under the new standard, a name error is fatal if a search under the correct name, using the filing office's standard search logic, would not disclose the financing statement.12 Thus, the focus will be on the degree of tolerance built into the relevant office's search logic.

The search logic standards are still evolving at this early stage of the revision process and some states may adopt unique standards. However, the International Association of Corporation Administrators has promulgated a set of Model Administrative Rules for revised Article 9 that has already been adopted by several states. These rules appear at http://www.iaca.org/sts/ and, as of early September, had been adopted in whole or part in Iowa, Minnesota, New Mexico, Virginia and Washington. These rules illustrate how small a margin for error may be provided by the new search logic-based test for seriously misleading errors.

Since a computerized search system generates results by applying standardized search logic to the name presented to the filing officer, human judgment does not play any role in determining the results of the search.13 Instead, the search logic rules convert both the name to be searched and the names in the index into a standardized format. Then the computer generates a search result based on exact matches between the search criteria and the database of filings. The search logic could be either very liberal or very strict. For example, an extremely liberal approach might be to convert the name "Libby Corp." into simply "L" and to similarly convert all other names beginning with an "L" into simply "L." This approach would be very forgiving of errors, but since the search result would include all "L" debtors, it would be uselessly overbroad. At the other extreme, the system could be very strict and produce only filings with "Libby Corp.," and not "The Libby Corp." or "Libby Corporation" or "LibbyCorp."

Although the search logic proposed in the Model Rules leans toward the strict end of the spectrum, it does include several features that may save an otherwise incorrectly listed debtor's name. First, the search logic ignores punctuation, accents, capitalization and spaces.14 Thus, if the financing statement contains these types of errors in the debtor's name, the errors will not render the statement ineffective. In addition, certain "noise words" also are ignored. Thus, the word "the" at the beginning of the name is disregarded.15 Further, most words or abbreviations indicating the nature of the organization at the end of the name are ignored.16 For example, endings such as "Corp.," "Co.," "Ltd.," "Credit Union" and "Attorneys at Law" are not considered.17

Thus, for example, if the debtor's correct name is "The BigDebtor's Store Inc.," the filing system would see the name as "bigdebtorsstore." If a secured creditor incorrectly listed the debtor's name as "Big Debtors Store Attorneys at Law," the system would see that as "bigdebtorsstore" and the error would not be seriously misleading.

On the other hand, once the names have been modified by the search logic, the search will produce financing statements only if the names "exactly match."18 Thus, even a minor misspelling or a typographical error in one of the critical characters will be fatal. For example, under the prior law, the failure to include the final "e" in the word "store" (i.e., listing the debtor's name as "The BigDebtor's Stor Inc.") probably would not have rendered the filing ineffective under the "reasonably diligent searcher" test. However, under the Model Rules, such an error would render the security interest unperfected and susceptible to a "strong-arm" attack by the bankruptcy trustee.

Human names present special difficulties. One must first determine the "correct" name of the debtor. As noted earlier, the revision gives clear rules for registered entities, but no rules for determining the correct names of individuals. The Model Rules do provide some flexibility that will allow names short of full legal names to be effective. First, with respect to an individual's first or middle names, initials are treated as the equivalent of all names that begin with that initial.19 Further, if no middle name or initial is listed, that is treated as the equivalent of all middle names or initials.20

Assume that the debtor's full legal name is "Robert John Smith." If the financing statement incorrectly lists the name as only "Robert Smith," the filing system would see the name as "Robert (any middle name) Smith." Since a search under the correct full legal name would discover the filing, the error would not be fatal. Similarly, a filing under "R. Smith" would be effective because the system would treat the "R" as equal to "Robert," and all other names starting with an "R." For the same reason a filing under "Robert J. Smith" would also be effective. However, a filing under only the middle and last names (i.e., "John Smith"), with no entry in the "First Name" field, would not be effective because the "no middle name equals all middle names" rule applies only to entries in the "Middle Name" field.

Once the names have been modified by the search logic, the search will produce financing statements only if the names "exactly match." No further flexibility is provided by the search logic. For example, the search logic does not treat common variations of first names or common misspellings or variations of last names as equivalent to the correct name. Thus, for example, a filing under "Rob Smith" or "Robert John Smythe" will not be discovered by a search under the debtor's full legal name.21 Such an error would be seriously misleading and would render the security interest susceptible to a "strong-arm" attack by the bankruptcy trustee. Similarly, a filing with an incorrect middle initial (e.g., "Robert P. Smith") would be ineffective.

Does the trustee automatically win if the financing statement lists only "Rob Smith"? Not necessarily. The secured creditor could argue that "Rob Smith" is a "correct" name for the debtor. Revised Article 9 does not tell us whether that argument prevails.


Footnotes

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

4 Generally, only a single filing in the debtor's state of location is required. See Warner, G. Ray, "Secured Transactions: New Filing Rules Follow the Debtor," 19 Am. Bankr. Inst. J. 16 (March 2000). Return to article

5 See, generally, Warner, G. Ray, "Secured Transactions: Documenting a Transaction Under Revised Article 9," 19 Am. Bankr. Inst. J. 20 (April 2000). Return to article

6 See §9-502(a). Although revised Article 9 does require additional information in the financing statement (see §9-516(b)(5)), only competing secured creditors and other purchasers can take advantage of errors involving those additional items. See §9-338. Return to article

7 See §9-504. Return to article

8 §9-506(a). Return to article

9 §9-506, cmt. 2 (emphasis added). Return to article

10 §9-503(a)(1). The debtor's trade names are neither sufficient nor required. §9-503(b) and (c). Return to article

11 §9-503(4). Special rules apply to decedent estates, trusts and debtors that have no name. See §9-503(a)(2), (3) and (4). Return to article

12 §9-506(c); see, also, §9-506(b). Return to article

13 Model Rules, §503. Return to article

14 Model Rules, §§503.2, 503.3 and 503.6. Return to article

15 Model Rules, §503.5. Return to article

16 Model Rules, §503.4. Return to article

17 The IACA list of almost 70 ending-noise words appears at http://www.iaca.org/sts/bus_ending.pdf. Note that only ending-noise words are ignored. Thus, for example, the system would not ignore the word "Corp" in the name "Warner Corp Financial Inc." Return to article

18 Model Rules, §503.8. Return to article

19 Model Rules, §503.7. Return to article

20 Id. Return to article

21 Since some states may adopt rules that do treat common variations as equivalents, it will be important to review the rules in the relevant state. Return to article

Journal Date: 
Monday, October 1, 2001

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