By Paul Hodnefield, Esq.
A UCC financing statement must include a description of the collateral subject to the security interest. The secured party has some flexibility for how to describe the collateral because Article 9 merely requires the record to reasonably indicate what is covered. Interested parties, however, may disagree regarding what constitutes a reasonable indication. The courts recently offered some guidance regarding reasonable indication of the collateral in the case of Grogan v. Harvest Capital Company, 2013 Bankr. LEXIS 4671 (9th Cir. B.A.P. Oct. 15, 2013).
The Grogans operated a Christmas tree farm in Oregon. They would plant the trees, let them grow and then harvest them for sale after approximately 12 years. To finance their operation, the Grogans took out $7 million in loans from Harvest Capital Company (“Harvest”) in 2006. The loans were secured by a combined mortgage/security agreement that covered, among other things, “All trees, bushes, vines and other permanent plantings now or hereafter located on the land.” (Emphasis added).
Harvest perfected its security interest in the personal property by filing a financing statement with the Oregon Secretary of State in 2006. The financing statement provided a collateral description nearly identical to that used in the security agreement. Harvest continued the financing statement in 2011.
Meanwhile, in 2008, the Grogans took out another loan from Demeter AG, LLC (“Demeter”). The Demeter loan was secured by a mortgage, security agreement and fixture filing. Demeter also filed a financing statement with the Oregon Secretary of State to perfect its security interest. Both the security agreement and financing statement described the collateral to include “All trees, bushes, vines and other permanent plantings now or hereafter located on the land.” Unlike the Harvest security agreement and financing statement, the Demeter collateral description went on to include a specific reference to “Christmas trees.”
On October 31, 2011, the Grogans filed a voluntary Chapter 11 bankruptcy petition. Shortly thereafter, the Grogans brought an adversary action against Harvest and Demeter (collectively the “Defendants”), seeking a declaration that the security interests in the Christmas trees were unperfected and unenforceable because the Defendants failed to adequately describe the collateral in both the security agreements and financing statements.
The Grogans claimed that the description of “all trees” was modified by the word “permanent.” Christmas trees, they argued, were “crops” and, by definition, were not permanent. Therefore, the description of the collateral was insufficient to indicate the security interest covered Christmas trees. The Grogans then moved for summary judgment.
The case eventually made it to the Bankruptcy Appellate Panel for the 9th Circuit (“BAP“), which had to determine whether the collateral descriptions provided by the Defendants were sufficient for purposes of Article 9. The BAP first noted that under Oregon law a description of collateral in the security agreement is sufficient if it reasonably identifies what is described or is otherwise objectively determinable. The BAP further observed that the reasonable identification test is satisfied if the description in the security agreement or financing statement provides enough information to enable third parties to identify the collateral upon reasonable inquiry.
Applying these basic collateral rules to the security agreements and financing statements at issue, the BAP immediately concluded that the Demeter records met the collateral description requirements of Oregon law. The security agreement and financing statement both used the term “Christmas trees” and included other references to personal property. Therefore, the records reasonably indicated that they covered Christmas trees.
The Harvest security agreement and financing statement, however, failed to specifically mention Christmas trees. The Grogans maintained that the reference to “permanent” was applicable to the description of “trees,” which therefore excluded Christmas trees because they were crops and not permanent.
The BAP concluded that the phrase “All trees, bushes, vines and other permanent plantings” was sufficiently broad to include Christmas trees. When taken as a whole, the collateral description provided other clues that would indicate to a third party that the description covered Christmas trees.
Furthermore, the context made the collateral, Christmas trees, objectively determinable. Upon reasonable inquiry a third party would have figured out that the Grogans owned a Christmas tree farm with approximately a million Christmas trees on the property and their sole source of income was the sale of Christmas trees. Consequently, the court held that the Harvest collateral description was also sufficient and that both Defendants held unavoidable perfected security interests in the Christmas trees.
The important thing to take away from this case for UCC filers is that a collateral description need not exactly describe the collateral. It must simply provide enough information to allow a third party to determine what collateral the security agreement and financing statement cover after reasonable investigation.
From a searcher’s perspective, it is important to note that reliance solely on an interpretation of the collateral description found in the financing statement or security agreement may be a risky practice. The courts expect interested parties to conduct further inquiry beyond the UCC records to determine specifically what property is subject to the security interest.
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 firstname.lastname@example.org or 800-927-9801, ext. 62375.