By Paul Hodnefield, Esq.
The purchase-money security interest (“PMSI”) can give a creditor the first priority security interest in goods that it enabled the debtor to acquire, even if other lenders hold prior perfected security interests in the same collateral. However, because this is an exception to the general “first to file” priority rule, secured parties must strictly comply with the Article 9 PMSI requirements. The recent case of T. Gluck & Co., Inc. v. Craig Drake Mfg., Inc., 2013 N.Y. Misc. LEXIS 2384 (N.Y. Sup. Ct. June 4, 2013) illustrates the potential risks of PMSI noncompliance for secured parties.
Craig Drake Mfg., Inc. (the “Debtor”) was a jewelry manufacturer. In 1989, the Debtor entered into a revolving credit agreement with a lender that later sold the loan and security interest to Sovereign Bank (collectively, the “Bank”). The revolving credit agreement granted the Bank a security interest in the Debtor’s current and future accounts and inventory.
The Bank perfected its security interest in the Debtor’s assets by filing a financing statement on July 27, 1989. The Bank protected its security interest by filing continuation statements in 1994, 1999, 2004 and, most recently, in 2009.
In 1997, T. Gluck & Co. (“Gluck”) contracted to supply diamonds to the Debtor on consignment. Gluck and the Debtor entered into a consignment agreement. To protect its interest in the consigned goods, Gluck sent a notice to the Bank on January 31, 1997, and then filed a financing statement on February 24, 1997.
Several years later, in late 2009, the Debtor retained a firm to manage a going-out-of-business sale. The firm conducted the sale over a period of several months and then remitted most of the proceeds to the Bank. Gluck was not paid for some of the goods consigned to the Debtor.
Gluck brought a lawsuit against the Bank on December 31, 2009, alleging that it held the priority interest in the consigned goods and making claims for both conversion and violation of the New York Uniform Commercial Code. The Bank disputed Gluck’s allegations and brought a motion for summary judgment in its favor on all the claims asserted against it.
The court began its analysis by determining that under the UCC, Gluck’s interest in the consigned goods was a PMSI in inventory. Therefore, to have the priority interest in the goods, Gluck had to prove it complied with the PMSI requirements.
Article 9 has two requirements for a secured party to obtain a PMSI in inventory. The first is to perfect its security interest by filing a financing statement before the debtor receives possession of the inventory. The second is to send a notice to the holder of any conflicting security interest within five years before the debtor receives possession of the inventory.
In this case, Gluck sent the Bank a PMSI notice in 1997. However, the parties agreed that the 1997 notice was the only notice received by the Bank. There was no evidence that Gluck ever sent another notice of its claimed security interest in the consigned goods.
The court concluded that because the PMSI notice expired in 2002 and was never resent, Gluck was not entitled to PMSI priority. Instead, the general rule of first-to-file, first-in-line would apply. Under the general rule, the Bank had first priority because it was the first to file in 1989. Therefore, the court granted the Bank’s motion for summary judgment.
The important thing to take away from this case is that a secured party that claims a PMSI in inventory must not only strictly comply with the initial perfection and notice requirement, it must also resend the notices every five years. Failure to resend a notice will make the secured party’s security interest subordinate to prior perfected security interests under the general priority rules. To avoid this result, the best practice is for the secured party to resend its PMSI notices prior to the time it continues the financing statement every five years.
Paul Hodnefield is Associate General Counsel for Corporation Service Company (CSC) and a frequent speaker/writer on UCC search and filing issues. Please feel free to contact him with questions or comments at email@example.com or 800-927-9801, ext. 62375.