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Examining Two Standards of the UCC for Collateral Description

Submitted by UCS on December 13, 2021

Our guest blog post features an article written by Armstrong Teasdale Partner Jeffrey Wurst, who examines two standards of the UCC for collateral description.  Mr. Wurst explains why lenders must exercise caution when intending to lend against collateral that is represented not to be part of a prior lender’s collateral package.

The UCC has two standards for collateral description. Section 9-108 provides that the security agreement’s “description of personal … property is sufficient, whether or not it is specific, if it reasonably identifies what is described.”  It goes on to give examples (not requirements) of reasonable identification. However, it specifically prohibits super-generic description:

A description of collateral as ‘all the debtor’s assets’ or ‘all the debtor’s personal property’ or using words of similar import does not reasonably identify the collateral.

On the other hand, the UCC permits super generic descriptions of collateral on the financing statement. Section 9-504 provides:

A financing statement sufficiently indicates the collateral that it covers if the financing statement provides: 1) a description of the collateral pursuant to §9-108, or 2) an indication that the financing statement covers all assets or all personal property.

So the standard for a security agreement is specific while the standard for a financing statement is generic.  No problem when you get a UCC search, which shows a prior lien on “all assets.”

But what if the financing statement merely provides that the collateral is what is described in the security agreement without anything further?  What do you do?  Do you rely on the security agreement your prospective borrower hands over to you?  What if it was amended to add more collateral?  And what if your intended borrower does not want you to approach the existing lender?

Now comes a decision from the U.S. Court of Appeals for the 7th Circuit, which is in Chicago, a significant commercial center.  Yes, the situation in this decision is different from what I described above but the issue is not.  The court indicated that the issue was a matter of first impression for our court: Whether Illinois’s version of Article 9 of the Uniform Commercial Code requires a financing statement to contain within its four corners a specific description of secured collateral, or if incorporating a description by reference to an unattached security agreement sufficiently ‘indicates’ the collateral.

This decision was not about a dispute between lenders as to whom held a valid interest.  It was an action by a Chapter 7 trustee against First Midwest Bank (FMB). FMB made a loan to 180 Equipment.  The security agreement contained 26 categories of collateral, such as accounts and goods.  Instead of using the “all asset” description in the financing statement, FMB, instead, described the collateral as

All collateral described in First Amended and Restated Security Agreement dated March 9, 2015, between debtor and secured party.

When FMB brought an action against the trustee to recover almost $8 million it claimed to be the proceeds of collateral in which it held a properly perfected and senior interest, the trustee asserted a counterclaim under §544(a) of the bankruptcy code, that, as a statutory lienholder, the trustee’s lien was superior to the interest of FMB because FMB did not properly perfect its interest due to its failure to provide a sufficient collateral description.  The bankruptcy court ruled in favor of the trustee, and the appeal was certified directly to the 7th Circuit.

The appeals court stated:

A court must view the statute as a whole, construing words and phrases in light of other relevant statutory provisions and not in isolation. Each word, clause, and sentence of a statute must be given a reasonable meaning, if possible, and should not be rendered superfluous.

The court looked at §9-502, which requires that a financing statement:

1) provide the name of the debtor, 2) provide the name of the secured party or its representative and 3) indicate the collateral covered by the financing statement.

The court went on:

A financing statement that substantially satisfies these requirements is effective, even if it has minor errors or omissions that are not “seriously misleading.” … But if a financing statement fails these basic requirements, the lender’s interests are subject to avoidance under §544(a) of the bankruptcy code.

It recited official comment 2 of §9-102, as follows:

This section adopts the system of ‘notice filing.’ What is required to be filed is not, as under pre-UCC chattel mortgage and conditional sales acts, the security agreement itself, but only a simple record providing a limited amount of information (financing statement)… The notice itself indicates merely that a person may have a security interest in the collateral indicated.  Further inquiry from the parties concerned will be necessary to disclose the complete state of affairs.

The court held that the financing statement is an abbreviation of the security agreement and concluded:

The approach … to financing statements supports the conclusion that incorporation by reference is permissible in Illinois as “any other method” under § 9-108, so long as the identity of the collateral is objectively determinable. That requirement is met here by the security agreement’s detailed list of the collateral.

The plain and ordinary meaning of Illinois’s revised version of the UCC allows a financing statement to indicate collateral by reference to the description in the underlying security agreement.

Reversed.  Success to FMB.  But what can we take away from this?

First, of course, FMB could have avoided a ton of aggravation (and legal costs) if it merely described its collateral as “all assets” on the financing statement, or even “all assets other than…” assuming its list of 26 was not intended to be all inclusive.

The more significant issue, referring back to the situation described above, is that lenders must exercise caution when intending to lend against collateral that is represented not to be part of a prior lender’s collateral package.  In such a case, and when the prior lender’s financing statement does not clearly enumerate the collateral description (as the 7th Circuit stated), “Further inquiry from the parties concerned will be necessary to disclose the complete state of affairs.”

In other words, if the proposed borrower does not want you to communicate with the prior lender as to the nature of the collateral — and you cannot enter into a reasonable intercreditor agreement, are you that hungry to do the deal?

All of this said, I have found that financing statements filed by equipment leasing companies to give notice of their interest in their leased equipment may describe collateral by reference to the lease agreement.  In examining these leases I have, on occasion, found broad granting clauses securing the lessee’s obligations.  Without that review, lenders would have found themselves subordinate to the prior filed lessor.

Jeffrey Wurst, who is a Partner with Armstrong Teasdale, has more than 30 years of experience and is well recognized for handling significant commercial finance and bankruptcy matters.  He is an esteemed fellow of the American College of Commercial Finance Lawyers and is a panelist on the American Arbitration Association’s National Roster of Arbitrators.

This article was originally published in the March/April 2020 issue of the abfjournal which can be found on their website at abfjournal.com.