By Paul Hodnefield, Esq.
Those who prepare and file UCC records often provide longer collateral descriptions than technically required under Article 9. For example, instead of simply describing the collateral as “All Assets,” a filer might provide an extended list of all the various collateral types. A bankruptcy trustee recently attempted to avoid a security interest on the grounds that such an extended collateral description was ambiguous and rendered the financing statement seriously misleading. The case is In re Sterling United, Inc., 2014 Bankr. LEXIS 4238 (Bankr. W.D.N.Y. Oct. 3, 2014).
From 2005 through 2007, United Graphics, Inc. (the “Debtor”) took out a series of loans from First Niagara Bank (“FNB”) totaling approximately $1.2 million. To secure repayment of the obligation, the Debtor granted FNB a security interest in all of its assets.
FNB filed two financing statements with the New York Secretary of State to perfect its security interest. The financing statements both described the collateral as:
All assets of the Debtor including, but not limited to, any and all equipment, fixtures, inventory, accounts, chattel paper, documents, instruments, investment property, general intangibles, letter-of-credit rights and deposit accounts now owned and hereafter acquired by Debtor and located at or relating to the operation of the premises at 100 River Rock Drive, Suite 304, Buffalo, New York, together with any products and proceeds thereof including but not limited to, a certain Komori 628 P & L Ten Color Press and Heidelberg B20 Folder and Prism Print Management System. (Emphasis added by the court).
In 2012, the Debtor changed its name to Sterling United, Inc. and moved to a new street address. FNB promptly filed UCC3 amendments to reflect the new name. However, FNB did not amend the collateral descriptions to reflect the new address.
Shortly thereafter, the loan went into default. By February 2013 FNB was vigorously liquidating its collateral. About that same time, FNB amended the financing statements to reflect the new address of the Debtor in the collateral statement. FNB’s enforcement of its security interest was interrupted in May 2013 when other creditors filed an involuntary Chapter 7 bankruptcy petition against the Debtor.
The Trustee brought an adversary action against FNB seeking to recover more than $300,000 in payments made by the Debtor and another $300,000 in proceeds of the collateral that FNB liquidated. The Trustee claimed that the collateral descriptions in the originally filed UCC records were needlessly convoluted, making the records seriously misleading under UCC § 9-506. Therefore, the Trustee claimed it could recover those funds on behalf of the Debtor’s unsecured creditors.
In response, FNB argued that the collateral statements satisfied the requirements for sufficiency under UCC Article 9. Both FNB and the Trustee then filed cross motions for summary judgment on their claims.
The court first addressed whether the Trustee could avoid the security interest with respect to payments made to FNB by the Debtor prior to the preference period. After concluding that the Trustee could not avoid the security interest entirely, the court narrowed the issue to whether the Trustee could recover the amounts collected by FNB during the 90-day preference period prior to the bankruptcy. The outcome of that issue depended on whether the collateral descriptions made the financing statements seriously misleading.
The Trustee offered the testimony of an expert linguist to demonstrate the ambiguity of the collateral description used in the original financing statements. The linguist concluded that two interpretations were possible. One interpretation favored FNB and the other favored the Debtor’s unsecured creditors.
The court, however, did not see the alleged ambiguity as a problem. The court observed that the collateral description could be paraphrased as simply “all assets of the Debtor, including X, Y and Z located at 100 River Rock Drive, but the collateral is not limited to X, Y and Z.” Furthermore, a hypothetical creditor may be presumed to have a certain level of sophistication and diligence when reading the collateral description and acting on whatever notice it provides.
According to the court, the test of whether irregularities in the collateral description made the record seriously misleading was not whether a particular party, in this case the Trustee, was actually misled, but rather whether a reasonably diligent searcher would be misled by the irregularity. Here, the financing statements reflected all the necessary information and, assuming that a reasonable or prudent search would have disclosed them, a hypothetical creditor would have learned of the claim and details. Thus, the notice filing served its purpose. Consequently, the court granted FNB’s motion for summary judgment.
The takeaway from this case is that searchers must be reasonably diligent when interpreting potentially ambiguous collateral statements. A financing statement only needs to reasonably identify the collateral covered by the security interest. The courts generally expect that UCC searchers will make further inquiries to identify the specific collateral covered. Searchers, therefore, should err on the side of caution and contact the parties involved to resolve any potential ambiguities in the collateral description.
Paul Hodnefield is Associate General Counsel for CSC and a frequent speaker/writer on UCC due diligence issues. Please feel free to contact him with questions or comments at email@example.com or 800-927-9801, ext. 62375.