Can a secured party rely on an old financing statement to perfect a new security interest? That is a question lenders often ask when entering into a new transaction with an existing client. It was an issue before the court in a recent case, In re: Oak Rock Financial, LLC, 2015 Bankr. LEXIS 866 (Bankr. E.D.N.Y. March 19, 2015).

Oak Rock Financial, LLC (the “Debtor”), an asset-based lender, obtained funding from Israel Discount Bank of New York (“IDB”). As part of the transaction, the Debtor granted IDB a security interest in substantially all of its assets. IDB filed a UCC financing statement to perfect its security interest on July 31, 2001.

In 2006, the Debtor entered into new security agreements with IDB and a group of additional new lenders. IDB acted as the administrative agent for the group.

The 2006 security agreements granted a security interest in substantially all the Debtor’s assets to IDB as Agent, as distinguished from IDB itself. IDB filed a financing statement to perfect the security interests created by the new security agreements on May 9, 2006. In addition, IDB filed two UCC-3 amendments for its 2001 financing statement. The first was an amendment to change the secured party name so it reflected “ISRAEL DISCOUNT BANK OF NEW YORK AS ADMINISTRATIVE AGENT.” The second was a UCC-3 assignment from simply IDB’s name to “ISRAEL DISCOUNT BANK OF NEW YORK AS ADMINISTRATIVE AGENT.”

Not long after, North Mill Capital, LLC (“North Mill”), Medallion Bank, and Medallion Financial Corp (collectively the “True Participants”) purchased from the Debtor some loans that the Debtor had made to third parties. The True Participants’ interest in the loans was perfected automatically under UCC § 9-309 without the need to file a financing statement.

In 2013, the Debtor ran into financial difficulties. IDB and the other lenders secured by the 2006 security agreements filed an involuntary Chapter 7 bankruptcy petition against the Debtor on April 29, 2013. The case later converted to Chapter 11.

IDB failed to file a continuation statement for the 2006 financing statement, which caused the record to lapse in 2011. However, IDB did file continuation statements for the 2001 financing statement in 2006 and again in 2011. Consequently, the 2001 financing statement remained active at the time of the bankruptcy.

One of the issues before the bankruptcy court was which party had the superior interest in the loans that the True Participants purchased from the Debtor. Both IDB and the True Participants made cross-motions for summary judgment on the priority of their interests.

IDB claimed that it held the priority security interest in the loans and was perfected by the 2001 financing statement. The True Participants, however, argued that the 2006 security agreements satisfied the prior loan with IDB and extinguished the 2001 financing statement. In addition, the True Participants advanced other claims, including that the 2001 lien was never transferred to IDB as Agent and that IDB as Agent relied on the 2006 financing statement for perfection, but that record had lapsed.

The court began by noting that IDB as Agent could not rely on the 2006 financing statement for perfection of its security interest. That financing statement lapsed in 2011. Turning to the effectiveness of the 2001 financing statement, the court observed that UCC § 9-502(d) expressly allows a financing statement to be filed before the grant of the security interest. The fact that the 2001 financing statement was filed five years before the debtor granted the security interest to IDB as Agent did not impair the effectiveness of the record under the UCC.

Nor did the assignment have any effect on the priority established by the financing statement. Perfection, according to the court, does not apply to a particular party, but to the security interest itself. Any party searching the public record would have found that the 2001 financing statement was assigned to IDB as Agent and, after further investigation, would learn that the Debtor had granted a security interest in substantially all of its assets to IDB as Agent in 2006.

The court concluded that because the 2001 financing statement remained of record, was not terminated, and never lapsed, that IDB as Agent was entitled to claim the first priority interest as of the effective date of the 2001 financing statement. The court went on to say:

Any third parties, including the True Participants, who failed to discover or who chose to ignore the 2001 Financing Statement acted at their peril. Ignorance or negligence is no defense as they are charged with knowledge of the 2001 Financing Statement and the “true state of affairs” between the Debtor and IDB as Agent. Whether they were aware of the existence of the filing and chose to ignore it or failed to discover the filing, the legal consequences are the same.

The court held that the priority rules placed IDB as Agent in first position. While there were a number of other disputed matters still to be decided in this case, the court granted summary judgment in favor of IDB as Agent on the priority issue.

The takeaway from this case for those who file UCC records is that a prior financing statement can, under the right circumstances, be effective to perfect a security interest that arises at a later time. However, secured parties should review the relevant facts of each transaction to determine whether it is safe to rely on the prior record to perfect the later security interest.

Those who search the UCC records can also learn from this case. An unlapsed financing statement should never be disregarded just because it appears that the secured party has been paid in full or the record appears unrelated to a current transaction. Any third party will take their interest subject to the earlier unlapsed record until it has either lapsed by time or been effectively terminated.

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 phodnefi@cscinfo.com or 800-927-9801, ext. 62375.

UCC Expert’s Corner: Old Financing Statement Perfected New Security Interest