Puerto Rico Case Highlights Need for Secured Parties to Adhere to Good Practices in Documenting Secured Transactions

Manufacturers encounter financing statements in many contexts – as a borrower, as a supplier of goods sold on credit, as a seller in a leveraged acquisition, as a seller of equipment where financing is provided to the buyer (purchase money financing), or as a supplier providing secured credit to a distributor. As simple and commonplace as they may seem, the requirements for financing statements are technical and the consequences of failure to satisfy them are draconian.

Secured parties and debtors alike enter into their deals with expectation that the deal will “hold up”: payments will be made when due and ultimately the collateral will be released as agreed. But often times, breaches occur and secured parties turn to the debtor’s assets to satisfy their debts. In such situations, the secured party with the higher priority will, in most cases, get access to the debtor’s assets before more junior and unsecured creditors. With bankruptcies and reorganizations continuing to make headlines, understanding the foundations of filing a valid financing statement and perfecting your interest, could save your company from losing its priority battle.

In order to properly perfect your interest, your financing statement must (i) provide the correct legal name and exact spelling of your debtor’s name; (ii) provide the name of the secured party or a representative thereof; and (iii) include sufficient description of the collateral. Additionally, the financing statement must be filed with the correct filing office. While satisfying those seemingly innocuous requirements seems easy, there are also some easy ways to get it wrong. In this blog post, we discuss the two deficiencies found in Puerto Rico’s case and provide a concise guide on good practices for preparing and filing a financing statement.

I. Perfection Problems

Last month, the First Circuit decided a case arising out of the restructuring of Puerto Rico’s ballooning debt. Certain financing statements securing Puerto Rico’s bond debt (valued at $2.9 billion) were held inadequate for failure to sufficiently describe the collateral. In re Financial Oversight and Management Board for Puerto Rico v. Puerto Rico AAA Portfolio Bond Fund, 914 F.3d 694 (2019). In addition to the collateral description issue, the court ruled that relying on the English translation of the debtor’s name as it appears in the organic documents is sufficient to accurately describe the debtor.

First Perfection Problem: Collateral Description

The financing statements, filed in 2008 under Article 9 in effect at the time in Puerto Rico, failed to describe the collateral by type or attach a collateral description. The debtors argued that because of this deficiency, the security interest for the $2.9 billion debt was unperfected and therefore subject to avoidance under the Bankruptcy Code. The Security Agreement attached to the 2008 financing statements referenced (but did not attach) a Resolution which in turn described the Pledged Property. The secured parties argued, however, that ‘mere reference’ in the Security Agreement to the definition of Pledge Property in a publicly accessible document, the Resolution, is sufficient notice to unwary parties. To the secured parties, collateral description in financing statements is only ‘a starting point’.

The court rejected the ‘starting point’ argument. Ruling on the facts of this case, the court decided that collateral description is insufficient when a) the collateral is not described even by type on the face of the statement; b) the statement and its attached documents do not tell interested parties where to find the referenced document; and c) the document containing the fuller description of collateral to the statement is not at the UCC filing office.

Luckily for the Bondholders, their latter filing in 2015 and 2016 cured this deficiency. This time the financing statements listed the collateral description as “the Pledged Property and all proceeds thereof and all after acquired property as described more fully in Exhibit A attached hereto and incorporated by reference”). The new financing statement attached “Exhibit A” which, in addition to defining the Pledged Property, defined all the capitalized definitional terms used to describe the collateral.

Second Perfection Problem: Debtor’s Name

Puerto Rico adopts two official languages: Spanish and English. The statute creating the debtor was promulgated in Spanish and accompanied by an official English translation. The official English translation of the debtor’s Spanish name used two different renditions. The debtor argued that the official English translation in the opening section of the Enabling Act should be given precedence over the English translation used elsewhere in the Enabling Act (and in the financing statement). The court disagreed. The court ruled that requirements under the relevant U.C.C. provision allow the filer to provide the name ‘as stated’ in the public organic record ‘which purports to state, amend, or restate the registered organization’s name’. The court said that the ‘purport to’ language directs the focus to the entire public record instead of confining it to the opening clauses.

More Problems: Incorporation by Reference

Although the court in In re Financial Oversight dismissed the secured parties’ incorporation by reference argument as ‘beside the point’, the issue resurfaced in another case. First Midwest Bank v. Reinbold (In re 180 Equip., LLC), 2018 Bankr. LEXIS 2482 Bankr. C.D. Ill. (2018). Here, the financing statement did not describe the collateral but incorporated by reference a document describing the collateral without appending such document to the filed statement. The district court ruled on summary judgment and as a matter of first impression that such practice is insufficient to perfect the security interest under the Illinois U.C.C. The case is under appeal.

II. Good Practices

Financing statements are indispensable tools of secured transactions. Perfection of security interests in collateral is not hard to attain, but it could be easily missed. The following provides helpful tips to consider when preparing and filing a financing statement in light of the cases and decisions presented above:

Under the current rules, U.C.C. 9-504, secured parties have two safe harbors to ‘sufficiently’ describe collateral in their financing statements:
- use generic UCC types to describe the collateral (such as inventory, equipment, goods, or proceeds); or
- insert blanket language indicating interest in “all assets or all personal property”.
When the pledged property involves carve outs or real estate, attaching an exhibit sufficiently defining the property in question is good practice.
Use the debtor’s legal name exactly as stated in the official organic documents most recently enacted (most recent articles of organization or charters for companies).
Using trade names (d/b/a) or nicknames for the debtor’s name when filing the financing statement is not effective.
File the financing statement with the correct filing office. For personal property (such as equipment and inventory) of registered organizations (such as corporation and limited liability companies), creditors should file the financing statement in the filing office for the state in which the organization was incorporated even if the operations of the debtor are at a different state.
If your collateral includes real estate or fixtures (movables that are considered part of the property such as an assembly line), consult the state and local law where the real property is located to determine the appropriate filing office and any recordation requirements.

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