Can Subsequent Creditors Rely Upon the Accuracy of Existing UCC-1 Financing Statements?

UCC-1 Financing Statements

Collateral descriptions in Uniform Commercial Code (“UCC”) financing statements have been the genesis of numerous conflicts between creditors.  The purpose of a financing statement is to give notice to subsequent creditors of a prior security interest in personal property .  In order to achieve these objectives the financing statement must accurately describe the collateral.  However, a subsequent creditor may be required to do more than simply review active UCC-1 financing statements  to determine whether a given debtor has already encumbered its personal property assets, and ambiguities may only serve to impose additional duties of inquiry on the subsequent creditor.

This was the subject of a dispute recently decided in the United States Bankruptcy Court for the Western District of Missouri in In re: 8760 Service Group, LLC (In re 8760 Service Group, LLC, 65 Bankr. Ct. Dec. (CRR) 170, (Bankr. W.D. Mo. 2018)).

In In re: 8760 Service Group, LLC, the debtor, 8760 Service Group, LLC (“Debtor”), operated a custom industrial construction and fabrication business with its office located at 1803 W. Main Street, Sedalia, Missouri. (“Main Street Property”).  The creditor, Bancorpsouth Bank (“BCS”) , made a number of loans to Debtor and Pelham Property, LLC (“Pelham”), a single purpose entity formed to own the real property located at 5105 Pelham Drive, Sedalia, Missouri (“Pelham Property”), from which Debtor operated its fabrication facility.  Debtor was the only member of Pelham. To secure these loans, Pelham executed and recorded a deed of trust and fixture filing on the Pelham Property in favor of BCS, and Debtor granted BCS a personal property security interest in collateral described in BCS’s UCC-1 financing statement as “all accounts receivable, inventory, equipment, and all business assets located at [the Main Street Property]”.  Subsequently, a blast booth was installed in the building located at the Pelham Property.  It was funded by proceeds from Pelham’s construction loan from BCS.  However, the construction contract and the invoices for the blast booth’s construction were in the name of Debtor.

Subsequently, Hudson Insurance Company (“Hudson”) provided payment and performance bonds for the account of the Debtor.  To secure Debtor’s repayment obligations to Hudson in connection with the bonds, Debtor granted security interests to Hudson in substantially all of Debtor’s property.  Hudson filed a UCC-1 financing statement with respect to Debtor’s inventory, equipment and accounts.

The Debtor and Pelham subsequently filed Bankruptcy, and a dispute arose between BCS and Hudson as to the existence and priority of their respective and competing security interests in the inventory and equipment of the Debtor, including the blast booth located on the Pelham Property.

BCS contended that the collateral description in its UCC-1 financing statement filed against the Debtor could reasonably be interpreted two ways: (1) that the address restricts all described collateral to only that which is located on the Main Street Property, OR (2) that the commas separating out the various types of collateral, and addition of the second “all” (i.e., “and all business assets located at…”(emphasis added)) serve to limit the effect of the reference to a specific property address only to the business assets of the Debtor, and that BCS’s security interests in “…all accounts receivable, inventory, equipment…” mean precisely that; all accounts receivable, inventory, equipment, wherever they may be located, including equipment (i.e., the blast booth) located on the Pelham Property.  BCS went further in asserting that since there were two reasonable interpretations then its financing statements were not seriously misleading and triggered a duty to further investigate the extent of BCS’s security interest.  The Court agreed with BCS.  The Court reiterated that it views the validity of a financing statement in terms of whether “it provides notice that a person may have a security interest in the collateral claimed.”  Further, the Court noted that the UCC recognizes further inquiry may be necessary and that therefore, errors or omissions in the description of the collateral do not render financing statements ineffective unless they are seriously misleading.  Based upon that reasoning, the Court held that Hudson’s claim in the Debtor’s equipment (including the blast booth) was subordinate to BCS’s.

This case should serve to remind creditors that if the collateral description in a pre-existing UCC-1 financing statement is ambiguous or subject to multiple interpretations, it is incumbent upon the subsequent creditor to reach out to the existing creditor(s) to clarify and/or confirm the nature and extent of any pre-existing liens on the collateral.

Christopher Gravell

By Christopher Gravell
Associate at Frandzel Robins Bloom & Csato, L.C.

Implications of the Changes to the LIBOR Rate on the Existing Loan Market

LIBOR Reform

Following the financial crisis of 2007 and 2008 significant reforms were called for in the London Interbank Offered Rate (ICE LIBOR or “LIBOR”). These reforms were spurred by three issues: regulator’s fears over having a single rate with no credible alternative or back-up rates; allegedly inaccurate or manipulated individual panel bank submissions scandals; and the implication that senior United Kingdom regulators asked banks to alter their reporting to project financial strength. These proved to be more than the United Kingdom could stand, and thus Libor was transferred from the control of the bank market association to a regulated independent operator. This change opened the door to two major challenges: other rates that are proposed to supplant traditional LIBOR and how to deal with those changes in LIBOR regulation, especially in the context of extant loans.

For United States lenders there are two main choices going forward. U.S. banks can either elect to stay with the reformed LIBOR rate operator, or switch to the U.S. organized Secured Overnight Funding Rate (“SOFR”). The SOFR is a rate that is a secured overnight Treasuries repo rate (i.e., the interest rate paid on overnight loans collateralized by US government debt; collateral that is high-quality, liquid, and accepted as collateral by the majority of intermediaries in the repo market). One of the most glaring omissions in the calculation of the SOFR is that, unlike LIBOR, it does not take into account bank credit risk, thus the resulting rate is frequently significantly lower than the corresponding LIBOR rate for the same period. The New York Fed anticipates publishing this rate beginning April 3, 2018.

The greatest complications of any of the new rate is in how it affects outstanding loans and obligation of lending institutions that are already pegged to the LIBOR rate.

If the LIBOR reforms prove adequate and are widely accepted by the market, then there are should be no necessary changes to existing contracts. The main issue for banks would be in ensuring that they insert some language into new credit agreements to adequately address specifically that they will be applying the LIBOR rate as its calculation methodology may change from time to time.

If the LIBOR reforms are deemed inadequate by the market and backup or replacement rates become relevant, then there are a number of issues that arise and must be addressed. The largest and most glaring issue is how to address contracts that do not adequately provide for a transition to a rate other than LIBOR. These can be addressed in four main ways:

  • Option 1: An overriding law is passed, which statutorily forces conversion. The main risk to this option is that not all jurisdictions possess the legislative power to implement this option.
  • Option 2: Parties agree to amend the existing contract to provide for transition to the new rates. The main risk with this option that the SOFR is new and will likely require fine-tuning to address any kinks in the calculation of a fair and representative rate, thus any amendment will likely need to involve flexibility for the change rate without the need for amendment every time.
  • Option 3: Just wait for maturity. Lenders could just wait until obligations mature and thus rely on the changes of the reformed LIBOR rate. This option will likely be adequate for short term contracts, but will become increasingly problematic and risky with contracts that extend beyond the transition date.
  • Option 4: Refinancing. The Lenders could always refinance debt instruments that are subject to LIBOR thus bringing them into immediate compliance. The risks associated with this method are in the fees and costs associated with such refinancing (i.e., for Borrowers, the refinanced debt may be more expensive than their existing debt, may give rise to prepayment penalties, or may trigger debt modification regulations)

Regardless of how the market addresses the changing interest rates the change itself can be detrimental to banks portfolios of existing credit obligations. To combat this, banks will need to be proactive in identifying outstanding credit instruments which will be affected by the changes in LIBOR and how they internally wish to address each outstanding credit individually.