By Paul Hodnefield, Esq.

Those who conduct UCC searches are responsible not just for finding all the relevant records, but also for correctly interpreting the results. An accurate interpretation requires access to information that is not available in the public records. An interested party must conduct further inquiry of the parties involved to learn the full state of affairs. Relying solely on the public record can prove costly, as the buyer of equipment learned in the recent case of Bishop v. Alliance Banking Company, 2013 Ky. App. LEXIS 151 (Ky. Ct. App. Oct. 11, 2013).

The case involved two Kentucky residents (the “Debtors”) who pledged existing equipment as security for a loan. In September 2010, the Debtors executed a promissory note in favor of Alliance Bank (the “Bank”) and granted the Bank a security interest in a backhoe. The Bank perfected its security interest by filing a financing statement with the Kentucky Secretary of State that described the collateral as “1999 CASE BACKHOE 580L SERIAL #1100249697.”

By December 2010, the Debtors were in default. The Bank commenced an action against the Debtors for breach of the promissory note and to obtain possession of the backhoe. The Debtors failed to appear, so the court awarded the Bank a judgment, determined that the Bank held the superior perfected security interest in the collateral, and granted the Bank possession of the backhoe.

Only after obtaining the judgment did the Bank learn two facts that complicated its efforts to take possession of the backhoe. First, in October 2010 the debtors sold the backhoe to Bishop without informing the Bank. The Debtors also gave the Bank with an erroneous serial number for the backhoe. The actual serial number was “JJG0249697” not “1100249697.” Consequently, the financing statement provided an incorrect collateral description.

After learning of these developments, the Bank amended its complaint to add Bishop as a defendant in the action against the Debtors. Later, the Bank brought a motion for summary judgment against Bishop, asserting that its perfected security interest took priority over any interest Bishop held in the backhoe.

In response, Bishop argued that he had purchased the backhoe in good faith, for value and without knowledge of the Bank’s security interest. Bishop claimed he had no notice of the Bank’s security interest because the erroneous serial number set forth in the financing statement failed to sufficiently describe the collateral. Furthermore, Bishop asserted that he had contacted the county clerk and was told there were no liens against the backhoe.

The court first addressed Bishop’s assertion that the financing statement failed to sufficiently describe the collateral. The standard cited by the court was that a collateral description is sufficient if it puts subsequent creditors on notice so that, aided by further inquiry, they may reasonably identify the collateral involved.

In this case, the serial numbers in question were similar and only off by three digits. Furthermore, the description did correctly describe the make and model of the backhoe. The court concluded this information was sufficient for Bishop, after further inquiry, to identify that the backhoe was the same collateral described in the financing statement.

The court also dismissed Bishop’s claim that the county clerk reported no lien on the backhoe. The county clerk was not the proper filing location under Kentucky’s UCC Article 9. The Bank’s financing statement was properly filed with the Kentucky Secretary of State. As a result, Bishop’s reliance on the county clerk’s report was misplaced.

The court held that the collateral description on the Bank’s financing statement was sufficient under Kentucky law. Therefore, the court ruled that the Bank’s security interest was superior to Bishop’s claimed interest and that the Bank was entitled to possession of the backhoe. The court concluded by granting the Bank’s motion for summary judgment against Bishop.

The important thing to take away from this case is that those who search the UCC records cannot take search results at face value. A financing statement, including related amendments, merely serves as the starting point for further research by interested parties. Those who rely exclusively on the UCC records without conducting additional inquiries significantly increase their risk if the debtor later defaults.

Paul Hodnefield is Associate General Counsel for Corporation Service Company (CSC) and a frequent speaker/writer on UCC due diligence issues. Please feel free to contact him with questions or comments at phodnefi@cscinfo.com or 800-927-9801, ext. 62375.

Backhoe Buyer Should Have Dug Deeper