By Paul Hodnefield, Esq.

The purchase-money security interest (“PMSI”) is a powerful tool that enables lenders to take priority over the holders of prior perfected security interests that cover the same collateral. Those lenders seeking to obtain a PMSI often take great care to comply with the statutory perfection requirements. Yet, the notice requirements for a PMSI in inventory are every bit as important. A secured party that fails to comply with the PMSI notice requirements is likely to find its security interest subordinate to prior conflicting interests. That was the outcome in a recent case, In re: Tsawd Holdings, 2019 Bankr. LEXIS 1181 (D. Del. Apr. 12, 2019).

The Tsawd Holdings case arose out of the bankruptcy filing by a national chain of sporting goods stores. In 2006, The Sports Authority Holdings, Inc. and its affiliates (collectively the “Debtor”) entered into a secured term loan (the “Term Loan”) with Bank of America (“BoA”) as administrative agent for a syndicate of lenders. As security for the loan, the Debtor granted the lenders a security interest in all of its inventory, including after-acquired inventory.

BoA perfected the security interest in the Debtor’s inventory by filing the necessary financing statements and, later, continuation statements. In 2015, Wilmington Savings Fund Society, FSB (“WSFS”) took over as successor administrative agent to BoA for the loan. The parties amended the related financing statements on December 31, 2015, to reflect WSFS as the secured party of record.

Meanwhile, the Debtor entered into a relationship with Sports Dimension to sell Body Glove apparel products on consignment. This type of consignment transaction falls within the scope of UCC Article 9 and is deemed a purchase-money security interest (“PMSI”) in inventory.

Sports Dimension filed a financing statement to perfect its PMSI in the consigned inventory on January 25, 2016. At the same time it sent notices to the holders of conflicting security interests. Despite the UCC3 Assignment listing WSFS as assignee, however, Sports Dimension sent the PMSI notices related to the Term Loan only to BoA and not to WSFS.

About a month after Sports Dimension sent the PMSI notices, the Debtor filed a voluntary petition for bankruptcy under chapter 11. A dispute arose between Sports Dimension and WSFS regarding priority in the Debtor’s inventory. Sports Dimension claimed it held a perfected PMSI in the consigned Body Glove inventory and proceeds arising from the Debtor’s post-petition sale of those goods. WSFS disputed Sports Dimension’s claim to the inventory.

The Debtor brought an adversary action against Sports Dimension and asked the court to decide the competing claim of the parties. Sports Dimension and WSFS then made cross-motions for summary judgment on their claims.

The issue of priority boiled down to the sufficiency of the PMSI notice sent by Sports Dimension to BoA. In support of its claim, WSFS pointed out that it had already amended the financing statement to list its name and address as the secured party before Sports Dimension sent the notice. WSFS asserted that Sports Dimension failed to provide notice to the appropriate address and, accordingly, failed to satisfy the requirements to obtain a PMSI in inventory.

The court agreed with WSFS. There was no evidence that BoA forwarded the notice to WSFS. Moreover, Sports Dimension didn’t offer any legal authority for the claim that the PMSI notice to BoA was effective for purposes of notice to WSFS. Therefore, the court ruled that WSFS was entitled to the disputed inventory and proceeds because it had been first to file its financing statement and no PMSI exception to the general priority rules would apply.

The takeaway from this case is that secured parties should err on the side of caution when determining which parties should receive such notices. As an exception to the general priority rules, a PMSI in inventory requires the secured party to strictly comply with the PMSI notice requirements. Any deviation could result in an insufficient notice. If the secured party fails to sufficiently comply with the notice requirements, it will lose PMSI priority and find its security interest subordinate to that of the secured party that was the first to file on the collateral.

Learn More:

Recorded Webinar – “The Essentials of Purchase-Money Security Interests”

Guide –“Purchase-Money Security Interest Best Practices”

Paul Hodnefield is associate general counsel for CSC® and is a frequent speaker and writer on UCC due diligence issues. Please feel free to contact him with questions or comments at paul.hodnefield@cscglobal.com or 800-927-9801, ext. 61730.

UCC Expert’s Corner: Do Not Overlook Assignee When Sending PMSI Notices