Preliminary Concepts and Due Diligence
Our new bite-sized webinar series, Briefly Speaking, helps paralegals tackle every day challenges more effectively.
This first webinar, UCC Article 9 Filing Essentials – Preliminary Concepts and Due Diligence, will discuss:
- Essential concepts that include perfection, priority, and notice filings
- Rules and exceptions for determining filing location
- Rules and exceptions regarding duration and effectiveness
Disclaimer: Please be advised that this recorded webinar has been edited from its original format, which may have included a product demo. To set up a live demo or to request more information, please complete the form to the right. Or if you are currently not on CSC Global, there is a link to the website in the description of this video. Thank you.
James: Hello, everyone, and welcome to today's webinar, "UCC Filing Concepts and Due Diligence," the first part in our seven-part Paralegal Series. My name is James Weir, and I will be your moderator.
Joining us today are Paul Hodnefield and Helena Ledic. Paul is the Associate General Counsel for CSC, where he is responsible for advising the company regarding real estate recording, notary, Uniform Commercial Code, and other public record transaction services. Helena is the Associate General Counsel for CSC in the Chicago office. She is a business attorney, advising senior management and law firms on strategy, business, legal, and technology matters. And with that, let's welcome Paul and Helena.
Helena: Thank you very much for that introduction, James, and thank you, Paul, for joining the Paralegal webinar series. What we're going to be covering today in our agenda, the first thing that Paul is going to take us through is essential concepts. He's going to cover perfection and priority. Then we're going to go into notice filing, and he's going to talk about the role of the filing office. After that, Paul will take us through the governing law and filing location, the general rules, and some exceptions that exist. Then what we'll do is we'll launch into duration and effectiveness, and, again, looking at the general rule and then the exceptions. And finally, we will finish up with a Q&A session at the end. So, with that, what we'd like to do is have Paul take it over and begin talking to us about the essential concepts.
Paul: Thank you. What we are talking about today are security interests, which are consensual liens that arise between the debtor and the secured party. As a consensual lien, they're a matter of contract. The debtor grants the secured party a security interest in exchange for a benefit, such as a loan or otherwise to secure the payment or performance of an obligation. And the secured party uses that security interest as a risk management tool because they have the ability to look to the debtor's assets to satisfy the obligation should the debtor default.
And this is all well and good between the debtor and the secured party, but there's a problem in that the grant of the security interest denies the debtor's assets to other parties that may also have a claim against the debtor. There are unsecured creditors. There are lien creditors, bankruptcy trustees, and all sorts of other parties that may, at some point, also have a claim to the debtor's assets, and they were not a party to that security agreement. They did not have anything to say about the debtor granting the security interest to the secured party.
And because that agreement between the debtor and secured party in effect adjusts the rights of innocent third parties, the courts will not enforce a security agreement unless the secured party does what's called perfect the security interest. Perfection is a critical thing to understand in the filing process because perfection is a way of protecting those third parties. Now, what perfection really is, is a way of protecting the third parties who are not a party to the security agreement, and the way that it protects them is by providing some sort of notice that somebody else has a claim on the assets of the debtor.
And the most common method of perfection is by filing a UCC financing statement. This puts a document out there that interested parties can search in a particular location and know whether somebody else has a claim against the debtor's assets. And what this does is it protects those third parties, and, more importantly, it makes the security interest enforceable against the claims of those third parties. Once it's perfected, the courts will enforce it. If a security interest is unperfected, it's not enforceable against third-party claims.
A related concept that's also very important is priority. Perfection deals with whether the security interest is enforceable, but oftentimes there are multiple claims against the same assets of the debtor. There may be multiple secured parties. There may be secured parties and unsecured creditors all claiming against the same assets. So what priority does, it gives the courts an orderly manner to sort out how these competing claims are satisfied. And the general rule under Article 9 is that priority runs from the earlier time of filing or perfection. So the first to file their financing statement is generally going to have the first priority security interest.
There is one exception to that, and that is the purchase-money security interest, which does give a super priority to those who finance assets of the debtor. It's a way of encouraging investment. And I'm not going to go into that much here, but I wanted you to at least be aware of that exception.
Another very important concept to understand is that the UCC is a notice filing system. What that means is that the records that get filed in the UCC index are merely notices. All they do is indicate that a security interest may exist. These records are not liens. They are not security interests in and of themselves.
In fact, they are not even enforceable documents. Nobody can sue to enforce a UCC financing statement, for example. It's the underlying security agreement that is the enforceable document.
But as mere notices, UCC records provide very minimal information. They don't provide the details of the transaction, so you're not typically going to be required as part of the filing process to provide dollar amounts, terms and conditions, covenants, and other things like that. All a UCC record is intended to do is put third parties on notice that a security interest may exist.
And under the UCC system, because these notices do not provide all the details of the transaction, those interested parties who search the records are expected to conduct further inquiry beyond the public record to learn the full state of affairs. Those who search the UCC records are not entitled to rely solely on the UCC record itself. They have to conduct further inquiry of the parties to learn all those details. And that is how the UCC system is intended to work. The filing office provides the information, and those who search the records are responsible for interpreting it and determining what it means.
In fact, the role of the filing office is somewhat limited. The role of the filing office is much more limited than many people realize. Under Article 9, the role of the filing office is purely ministerial. That means that, by statute, filing offices are not allowed to exercise judgment or discretion when they carry out their duties in the filing and search process. The filing and search process is actually designed to be a computer process, to be a machine process, to operate entirely without human judgment or discretion through electronic filing and electronic searching.
So, as a result, the filing office duties are limited when it comes to the intake of records and to providing data. Specifically, what the filing offices are responsible for is, first of all, to index records that come in by debtor name or file number so that they can be retrieved by both of those data elements.
Also, the filing office is limited in its reasons for rejection. The default rule at the filing office is they must accept records that are submitted unless a reason for rejection is set forth in statute, specifically in Section 9-516(b). A filing office is only permitted to reject for a reason set forth in Section 9-516(b). And when it comes to searches, the filing office will report only results that exactly match the name of the debtor that's being searched after they've applied their standard search logic.
So the filing office is not exercising judgment or discretion. Their duties are very narrowly tailored and very well laid out in statute and through the administrative rules.
In fact, the filing office has no duty or power with respect to certain critical elements of this process. Perfection, for example. The filing office plays no role in determining perfection or priority for that matter. All they do is they file the records that come in, and they report the information.
Perfection and priority is determined by functions outside the public record. That's between the debtor, the secured party in the courts, typically, and other interested parties. It's not determined by the filing office. So the filing office cannot determine perfection because that's dependent on factors outside the public record. The filing office cannot determine priority. That's determined sometimes by factors outside the public record.
Nor can a filing office determine effectiveness. Many people are surprised to realize that the filing office has no power whatsoever to make a record effective or ineffective. All they can do is make it retrievable or hidden.
Now the filing office does play a critical role in this process as the trusted repository for these UCC records. However, the filer has to be sure to get the correct filing office in which to file. If it's not filed in the correct filing office, the UCC record isn't going to be effective.
Now, determining the correct filing location is a multistep process. It begins with determining which state law governs perfection and priority. Generally, the law of the state where the debtor is located is going to govern perfection and priority. So the state where the debtor is located is typically the state in which to file.
Once the location of the debtor is determined, then it's necessary to look at UCC Section 9-501 as enacted by the state where the law governs perfection and priority. And this will point the filer to the correct filing office within the state.
Now, the general rule under Article 9 is that, for most types of collateral anyway, the place to file is the central filing office of the state in which the debtor is located. It is, therefore, very important to be able to identify the location of the debtor under Section 9-307. The location of the debtor under 9-307 is determined by the type of debtor. The most common type of debtor in a commercial transaction is the registered organization, and this includes corporations, LLCs, limited partnerships, and really any entity that comes into existence through the filing of or issuance of a public organic record.
If the debtor is a registered organization, it is located in the jurisdiction where it was formed or organized. For example, you can have a corporation that was formed in Delaware. Its headquarters may be in California. All of its employees may be in California, and all of its assets may be in California. Nevertheless, the correct place to file would be Delaware because that's where it was formed or organized.
For other types of organizations that wouldn't fall within the definition of registered organizations, the rule is a little different. There, the rule is that the debtor is located at its place of business, and if it has more than one place of business, it's located at its chief executive office. So the general rule of thumb here is look to the location of its chief executive office or headquarters, and the law of that state would govern perfection and priority.
For an individual, an individual is located at his or her principal residence in whatever state that is located within.
These are the primary types of debtors. There are other types of debtors out there that have special debtor location rules. I'm not going to go into those today, but I just want you to be aware that they do exist.
One exception for filing in the jurisdiction where the debtor is located occurs when the debtor is located in a jurisdiction that lacks a filing system. Under Article 9, if the debtor is located in a jurisdiction that does not require the public filing or registration of security interests in order to obtain priority over the rights of a lien creditor, then the debtor is deemed located in Washington, D.C.
Now, when might this occur? Well, most commonly, it's going to occur when the debtor is located in a foreign country. Many foreign countries do not have an Article 9 equivalent of the filing system, but many do and a growing number do. For example, Canada, New Zealand, and Australia all have personal property registries that are based upon the UCC as it was enacted in the U.S. But other countries may not have a direct equivalent to the UCC, and it may be questionable as to whether it satisfies the requirement for public filing or registration.
As a result, if the debtor is located in a foreign country, with the exception of Canada, Australia, New Zealand, it may be necessary to file in the District of Columbia. And in practice, what many filers do is they'll file in D.C., also file in the state where the foreign debtor conducts its business in the U.S., and then attempt to perfect, to the extent necessary, under the law of the country where the debtor is located.
But one doesn't have to look beyond the U.S. border to find examples of jurisdictions where they don't have a requirement for filing or registration of security interests. And those jurisdictions are sovereign Indian tribes. There are a number of Indian tribes within the U.S. that have enacted secured transactions laws, but sovereign Indian tribes are treated as the equivalent of a state.
And if the tribe hasn't enacted a secured transactions law, or if it has enacted the law but never implemented a filing system, which is the case in some tribal jurisdictions, then if the debtor is located within that tribal jurisdiction, it's going to be necessary to treat them as if there is no filing system. And as a result, it may be necessary to file in D.C., and as well as a backup to that, maybe filing in the state where the tribe is located.
Another exception to filing in the central filing office of the state where the debtor is located occurs where a state doesn't have a central filing office. There are two states where that's the case.
The first is Georgia. In Georgia, the rule under Section 9-501 is that the financing statement may be filed with the clerk of the superior court of any county within the state, regardless of where the debtor or the collateral are located. Georgia simply doesn't have a central filing office, so you file all of these with the clerk at the county. However, the county clerks are all linked together in a central index. The Georgia Superior Court Clerks' Cooperative Authority runs the index, and so they can all be searched centrally. Therefore, you have to file at the county, but a search that's conducted in Georgia will search all counties in one shot and identify the security interests wherever they're located.
The other state where this is an issue is Louisiana. In Louisiana, financing statements are filed with the parish clerk of any parish within the state, again, regardless of where the debtor or collateral may be located within the state. The only difference with Louisiana, and actually, I generally recommend this with Georgia as well, is be sure to file any amendments in the same jurisdiction where the financing statement was filed.
The final exception to filing in the central filing office where the debtor is located has to do with certain types of collateral that are related to real estate. There are three types of real estate-related collateral out there.
The first consists of fixtures, fixtures being personal property that either will be or has been so integrated into real property that an interest in the goods would transfer by deed. Another type of real estate-related collateral, timber to be cut, and finally minerals to be extracted. Because these types of collateral are so closely related to real estate, there is that overlap with real estate law. And therefore, in order to get priority over conflicting encumbrances on the same real property, they're treated differently, and they're handled differently.
The governing law is different for these. Unlike the default rule, where the governing law is law of the jurisdiction where the debtor is located, for real estate-related collateral like this, it's the law of the jurisdiction where the goods that either are or are to become fixtures are located. So the general rule here is you file in the state where the fixtures will be located or the timber to be cut or minerals to be extracted, where those are located, where the real property to which these relate is located.
So the general rule here, under 9-501, is that you file in the same office where a mortgage would be recorded on the affected real property. In other words, they get filed in the real estate records, and they get indexed in the real estate records because that's where people looking for real estate interests would come across them. So it would provide not only UCC notice but also would provide notice to those who are involved in real estate transactions.
There is one exception to this rule, and that is in Louisiana. Louisiana doesn't have real estate filing for UCCs at all. All of them are filed in the central index, even fixture filings.
The final preliminary concept I want to cover today has to do with the duration and effectiveness of filed records. The general rule under Article 9 is that a financing statement is effective for five years from the date of filing. There are some exceptions to that.
In Wyoming, they enacted a law a few years ago that extended the duration and effectiveness of UCC records out to 10 years for the general rule. Wyoming is the only state that has done this. And I'm not aware of any others that are looking at doing anything like that.
Another exception occurs if the financing statement indicates that it's being filed in connection with a public finance or manufactured home transaction. In that case, the record would be effective for 30 years under Article 9. But a word of caution about that. There are a number of states that enacted non-uniform provisions that do not recognize the extended effectiveness for these types of transactions. So if you're filing on a public finance or manufactured home transaction, be sure to check the applicable law in the state where the record will be filed to determine what the lapse date will be.
In Nebraska and Tennessee, there's an exception as well. If it's a public finance or manufactured home transaction indicated on the financing statement, there, in those two states, the record will be effective for 40 years.
There's also an exception for transmitting utilities. If the financing statement indicates that the debtor is transmitting utility, the record does not lapse. It's effective until terminated. And that's the case in all states with one exception, and that's Georgia. Georgia actually has a non-uniform duration and effectiveness provision and does not recognize any extended effectiveness. All UCC financing statements filed in Georgia are effective for five years.
A five-year duration and effectiveness may not always be enough, and for that reason, Article 9 does provide a rule to allow the secured party to extend the effectiveness beyond the initial five-year period. And that is done by filing a continuation statement.
The general rule upon filing a continuation statement is that the secured party can file that, and it will extend the effectiveness of the financing statement for an additional five-year period. And that is the case, even if it's dealing with a public finance or manufactured home transaction. Under the applicable section of Article 9, the filing of a continuation statement extends the effectiveness for five years. It doesn't matter what the initial transaction was. Of course, public finance or manufactured home transactions aren't going to be an issue for continuation for at least 12 more years, because those were new revised Article 9 concepts in 2001, and the first of those that will lapse won't be until 2031.
Now, the timing of the continuation statement is critical. A continuation statement has to be filed within a six-month window before the lapse date. So the secured party must file it in those six months before the lapse date. If it's filed more than six months before the lapse date, or if it's filed anytime after the lapse date, the continuation statement will not be effective to continue the effectiveness of the financing statement. And that will be the case even if the filing office accepts the continuation, indexes it, and resets the lapse date. Remember, the filing office cannot change the effectiveness of a record. Effectiveness is always determined by the filer and the filer's compliance with the Article 9 filing requirements.
Now, once a continuation statement is filed, it extends the effectiveness for five years from the date the financing statement would have lapsed in the absence of a continuation. It does not extend it from the date the continuation was filed. It extends it from the date it would have lapsed. So the continuation can be filed anywhere within that six-month window, and it will extend the lapse date to five years from the prior lapse date, not from the continuation filing date.
So that wraps up the preliminary concepts that any UCC filer needs to understand. And we'll go into more detail about the filing process and completing UCC records and so forth in other modules. So, with that, I'm going to wrap up the presentation and turn it back over to Helena.
Helena: Thank you very much, Paul, for taking us through the basics over here with UCC as our starting point with our very first module. For our audience, Paul took us through the essential concepts, perfection and priority, notice filing, and the role of the filing office. Then he ended up taking us into the governing law and the filing locations. We learned about the general rules and exceptions. And then Paul also took us into the duration and effectiveness, the general rules and, of course, the exceptions that are there.
And as you can see over here on this slide, you have our contact information in case you do want to reach out for us, but we do have a couple of questions that have come in from the audience that we would like to cover.
Well, very good, Paul. Thank you very much for taking us through that explanation. And I'd like to thank everyone in our audience for attending and, most importantly, to Paul for joining CSC for our very first seminar inside the Paralegal Series, the "UCC Article 9 Filing Essentials, the Preliminary Concepts and Due Diligence." Thank you very much for attending. We look forward to you joining us again in the future.