This article originally appeared on the State Bar of Wisconsin's Business Law Section Blog. It is republished here with permission.
Two recent cases held that a description of collateral in a financing statement was inadequate, because it referred to a description of collateral in a separate document, but did not attach that document.
This is an important issue, because failure to include an adequate description of collateral in a financing statement can leave a creditor’s security interest unperfected, making it vulnerable to the claims of subsequent secured parties who file complying financing statements and to avoidance by a trustee or debtor in possession if the debtor goes into bankruptcy.
The result can be substantial financial losses, which can run into the millions of dollars.
The First Circuit Court of Appeals recently held, in a case decided under the former version of Article 9 of the Uniform Commercial Code, that the description of collateral in a financing statement was inadequate when it referred to a security agreement attached as an exhibit, and the security agreement did not describe the collateral except by reference to another document which was not attached to the security agreement or the financing statement.1
It is important that this case was decided under the former version of article 9, because article 9 then required a financing statement to contain “a statement indicating the types, or describing the items, of collateral.” The First Circuit reasonably concluded that the financing statement at issue did not meet that standard.
The result should be different under the current version of article 9, which provides that a collateral description is sufficient “if the identity of the collateral is objectively determinable.”
The identity of collateral is objectively determinable if it is contained in a separate document that is identified in the financing statement, even if that document is not attached and does not appear in the public record.
Article 9 establishes a system of notice filing, and the financing statement is certainly enough to put third parties on notice that there may be security interest in the assets of the debtor, even if it refers to a separate document for the description of collateral. It would easy enough for any interested third party to ask the debtor for a copy of the document that describes the collateral, just as the third party would have to inquire further to ascertain the amount of the debt and other important information that is not required to be included in a financing statement.
The official comment to section 9-502 clearly describes the system of notice filing:
2. Notice Filing. 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. Section 9-210 provides a statutory procedure under which the secured party, at the debtor’s request, may be required to make disclosure. However, in many cases, information may be forthcoming without the need to resort to the formalities of that section.
Unfortunately, the Bankruptcy Court for the Central District of Illinois has held that the description of collateral in a financing statement was not adequate even under the current version of article 9 when it referred to the collateral described in a separate security agreement and did not attach a copy of the security agreement.2
I believe that case was wrongly decided for the reasons indicated above, and it is currently on appeal to the Seventh Circuit.
This is an important issue. Stay tuned for further developments.
1 In re the Financial Oversight and Management Board for Puerto Rico, ----F.3d----, 2019 WL 364029 (2019)
2 In re 180 Equipment, LLC, 2018 WL 4006294 (Bankr. C.D. Ill. 2018). Foley & Lardner LLP represents the secured party in the appeal to the Seventh Circuit of the decision in this case.