The New Governing Law for Perfection Under Revised UCC Article 9

By Ben Carpenter, J.D., Product Development Attorney, Bankers Systems, Inc., Contributing Author, CCH Focus

On July 1, 2001, revisions to the law of secured transactions will go into effect in the states that adopt Revised Article 9 of the Uniform Commercial Code (“Revised Article 9”). 

This article will focus on new provisions in Article 9 that determine the governing law for how to perfect and the effect of perfection under Revised Article 9. Except where noted, all section references are to the revised version of Article 9.

CHOICE OF LAW

The first step in perfecting a security interest is determining what law governs the transaction, or parts of the transaction. State laws vary, and state law may be preempted by federal law with respect to all or part of the transaction, so secured lenders must look at the characteristics of each transaction to determine the governing law.

Security interests in most personal property collateral are governed by Article 9 of the Uniform Commercial Code (UCC), but could alternatively or additionally be governed by common law, other state law (e.g., certificate of title laws), and federal law.

Security agreements and assignments typically contain a contract provision for a governing law. Under current UCC law, Section 1-105 provides that parties to a transaction may stipulate the state law that will govern their rights and duties so long as the chosen state bears a reasonable relation to the transaction. However, Section 1-105 provides that contrary provisions in the UCC will render the parties’ selection of governing law ineffective. Article 9 provides such an exception to the general rule in Section 1-105 by including rules for determining how to perfect a security interest in multiple-state transactions. These provisions are necessary to provide certainty in the area of perfection for the benefit of third party lien searches and priority disputes. These rules have been changed under Revised Article 9 and are the subject of this article.

GENERAL RULE

Under Revised Article 9, the rules for determining the governing law for perfection (e.g., where to file), the effect of perfection, and priority have been revised. This change will make a significant difference in secured lenders’ perfection procedures, particularly with respect to non-mobile (“ordinary”) goods that are currently governed by the law of the state in which the collateral is located.

Under Revised Article 9, as provided in Section 9-301, the general rule for determining the law that governs perfection of security interests is the state in which the debtor is located. Formerly, the general rule was collateral location, with exceptions for intangible collateral (e.g., accounts, general intangibles) and mobile goods (i.e., goods that are “normally used in more than one jurisdiction”). Changing the governing law to debtor location will have the effect of significantly reducing the number of filings since collateral consisting of non-mobile goods, such as inventory and equipment, will now require a single filing in one place—the debtor location—rather than in each of the states in which the collateral is located.

Once it is determined that the proper place to file is in the state where the debtor is located, the remaining question, and one which may have a new answer under Revised Article 9, is where the debtor is located. Under Section 9-307, the debtor’s location is determined by its entity type. If the debtor is an individual, the debtor is located in the state in which his or her principal residence is located. If the debtor is not an individual, the debtor’s location is determined by whether it is a “registered organization” under state law. Registered organizations, such as corporations, limited liability companies, and limited partnerships, are located in their state of registration. A non-registered organization is located in the state in which their business is located or, if there is more than one place of business, the state in which its chief executive office is located.

Revised Article 9 also provides new rules clarifying the proper treatment for debtors located outside the United States and debtors organized under federal law. With respect to debtors located outside the United States, individuals and entities are located in the foreign jurisdiction if such jurisdiction has a public filing system, but are located in the District of Columbia if the foreign jurisdiction does not have a public filing system. Regarding entities organized under federal law, the entity is located according to the rules of the law under which the entity is organized. Absent a designation of location under such law, the entity is located in the District of Columbia.

Particularly with respect to registration status and location, lenders should review their policies and procedures to determine the correct governing law. Loan documentation may require new warranties and covenants to determine and maintain the correct debtor location for purposes of verifying the state where perfection occurs. In addition, lenders should implement policies to monitor the entity status of their debtors, since registration status and registration state may change during the life of the loan.

EXCEPTIONS TO THE GENERAL RULE

There are exceptions to the general “debtor location” rule for certain types of collateral. Security interests perfected by possession, agricultural liens, and security interests covering fixtures, timber to be cut, as-extracted collateral, goods covered by a certificate of title, deposit accounts, investment property, and letter-of-credit rights have separate rules for determining the governing law. The following is a brief explanation of these exceptions.

Security Interests Perfected by Possession. The perfection, effect of perfection, and priority of possessory security interests are governed by the law of the jurisdiction in which the collateral is located. This provision mirrors the current baseline rule for documents, instruments, letters of credit, and ordinary (non-mobile) goods, but eliminates the qualification that the collateral location is determined by the last event on which is based the assertion that the security interest is perfected or unperfected.

Agricultural Liens. Under Revised Article 9, “agricultural liens” are statutory liens, not consensual security interests, in farm products. Section 9-302 provides that the local law of the jurisdiction in which farm products are located governs the perfection, effect of perfection, and priority of agricultural liens on the farm products. Although the creation of agricultural liens arises by law outside of Article 9, this section provides choice-of-law rules for agricultural liens subject to Article 9 perfection requirements under Sections 9-308 and 9-310. Under Section 9-317, the priority of an agricultural lien depends on whether the lien was properly perfected under Revised Article 9.

Fixtures, Timber, and As-Extracted Collateral. Perfection of security interests in certain collateral related to real estate is governed by the state in which the collateral is located. This means fixture filings (as opposed to UCC filings covering fixtures) and filings covering standing timber and “as-extracted collateral” must be made according to the laws of the state in which such collateral is located. “As-extracted collateral” is a new term under Revised Article 9, defined as oil, gas, and other minerals, and accounts arising out of the sale of such property, in which the debtor has an interest before extraction and to which a security interest attaches upon extraction. Of note, growing crops are not considered to be so related to real estate as to require an exception from the general debtor location rule.

Titled Goods. State certificate of title laws typically provide requirements for recording and perfecting liens on titled property. Under Section 9-303, perfection of goods covered by a certificate of title is governed by the state under whose certificate of title law the goods are covered. In related provisions, Sections 9-311 and 9-335 provide that filing a financing statement is not necessary to perfect a security interest in goods covered by certificate of title laws, and that a security interest in an accession is subordinate to a security interest in the whole that is perfected by compliance with the applicable state certificate of title laws. Lenders will need to ascertain whether the collateral is subject to state certificate of title laws and, if so, to determine whether the necessary steps have been taken to perfect the interest. To avoid any oversight, lenders should be aware that state certificate of title laws vary, with respect to both applicability and requirements, and a certificate of title may be issued by a state without any recognized relationship to the property or debtor.

Deposit Accounts. Revised Article 9 deals specifically with security interests in deposit accounts as original collateral. Under Section 9-109, the attachment and perfection of deposit accounts as original collateral are governed by Revised Article 9 in non-consumer transactions. Section 9-102 defines “deposit account” to be “a demand, time, savings, passbook or similar account maintained with a bank,” but does not include investment property or accounts evidenced by an instrument.

Section 9-304 provides that the law governing perfection of security interests in deposit accounts is the law of the depositary’s jurisdiction. The depositary’s jurisdiction is determined by agreement between the depositary and the account holder and, if there is no such agreement, the location of the depositary. Due to the ability to contract for governing law, and given the likelihood that all states will not adopt Revised Article 9 by July 1, 2001, depositary institutions with branches in more than one state may wish to contract for governing law in their deposit agreements to provide consistent treatment of security interests in deposit accounts governed by Revised Article 9. Lenders who take deposit accounts as collateral should be aware of the possibility that the debtor’s account agreement may specify a governing law different from the location of the depositary.

Investment Property. Since revisions to UCC Article 8, Article 9 has made conforming amendments relating to security interests in investment property. Investment property includes certificated and uncertificated securities, security entitlements and accounts, commodity contracts and accounts, and financial assets. Revised Article 9 implements additional terms governing such collateral.

Depending on the type of investment property, Section 9-305 provides the rules for determining what law governs perfection of a security interest in such collateral. Security certificates are governed by the law of the state in which they are located. Uncertificated securities are governed by the law of the state in which the issuer is located. Securities entitlements, securities accounts, commodity contracts, and commodity accounts are governed by the state in which the intermediary is located. However, in all cases, if the security interest is perfected by filing, or automatic perfected status is claimed by an intermediary, the law of the state in which the debtor is located governs perfection.

Letter-of-Credit Rights. Section 9-306 provides that the law of the state in which the issuer (or the issuer’s nominated person) of the letter-of-credit is located governs perfection, the effect of perfection, and priority of a security interest in a letter of credit right. However, there are two exceptions to this rule. First, if the issuer’s (or nominated person’s) jurisdiction is not a state, then the general rule in Section 9-301 applies, i.e., the debtor’s location determines the governing law. Second, if the security interest is claimed solely by virtue of the letter of credit being a supporting obligation for original collateral, the governing law is determined by the rules related to the original collateral. Article 9 defers to Article 5 for determination of the location of the issuer or nominated person.

CHANGE IN GOVERNING LAW

Revised Article 9 includes provisions governing perfection status upon a change in the governing law. Under the new provisions, lenders will need to monitor debtor entity status and location and take the proper steps within specified time periods to ensure that their interests remain perfected and that the perfection status relates back to the initial perfection date.

Section 9-316 governs perfection status upon a change in governing law. This section generally retains the grace period provided by current law, giving the secured party a four-month period during which its security interest remains perfected and in which it must take further action to maintain perfected status relating back to the original priority date. To accommodate the shift to debtor location as the default choice-of-law rule, Section 9-316 adds a new rule that extends the grace period to one year if the change in governing law is due to a transfer of collateral to a debtor in a different jurisdiction.

 

Impact of Revised UCC Article 9 on Secured Lenders’ Documentation and Practices Examined

This article will focus on the specific requirements for obtaining a valid security interest and new provisions governing the scope of the security interest. Except where noted, all section references are to the revised version of Article 9.

PROVISIONS GOVERNING THE ATTACHMENT OF A SECURITY INTEREST

Article 9 provides basic requirements for a security interest to attach, or become effective, against a debtor (the owner or someone else with rights in the collateral) and third parties with respect to the collateral. Section 9-203 sets forth the three requirements:

(1) value must be given;

(2) the debtor must have rights in the collateral, or the power to transfer rights in the collateral; and

(3) either the debtor signs a security agreement describing the collateral or the secured party obtains control over the property pursuant to the debtor’s security agreement.

These three requirements are similar to the requirements under the current version of Article 9, but there are several differences that may affect how security agreements are designed and executed.

Value Must Be Given

Under Section 9-203(b)(1), value must be given. This requirement recites the basic consideration requirement for a valid contract, but the “value’’ requirement is more broad than what may be considered adequate consideration under common law (see Section 1-201(44) for the definition of “value’’). As with current law, this does not require the value to be given to the debtor, nor does it specify when value must be given. Section 9-204(c) continues to validate security interests covering future advances, specifically rejecting case law that requires the future advance to be of a similar type or class as the original secured loan. If the collateral described in a security agreement is intended to cover future advances, the security agreement should include a reference to future debts or obligations in the description of the debts and obligations secured.

Rights in the Collateral

The debtor must have rights in the collateral for a security interest to attach to the collateral. Simply put, but subject to a few exceptions, a security interest attaches only to the rights of the debtor, and a debtor cannot give away rights it does not have. Section 9-203(b)(2) is written more broadly than current Article 9 to include the power to transfer rights in the collateral in addition to having rights in the collateral. While it has never been the law that the debtor must own the collateral, this clarifies, if not changes, the rights requirement to include the right to transfer. The primary significance of this change is to accommodate priority rules that give transferees greater rights than the transferor had. While in most cases the power to transfer will not be greater than the rights of the debtor, lenders should consider revising the conveyance provisions of security agreements to include all the rights of the debtor, including the right to transfer an interest, in the collateral so as not to limit any of the advantages the secured party may have under the new law.

Description of the Collateral

A security agreement must provide a description of the collateral that is covered, and the description must meet certain standards to be considered sufficient. New provisions of Revised Article 9 affect the standards for what constitutes a sufficient description.

Section 9-108 retains the former baseline standard that a description of collateral in a security agreement “is sufficient, whether or not it is specific, if it reasonably identifies what is described.’’ Section 9-108 goes further, however, to include examples of what will constitute a sufficient description (type, category, formula, etc.), including any method that makes “the identity of the collateral objectively determinable.’’ The examples make it clear, if not already so, that general descriptions may be used to identify the collateral. However, Section 9-108 expressly provides that a description of collateral as “all the debtor’s assets’’ or “all the debtor’s personal property,’’ or a similar description, is not sufficient to reasonably identify the collateral in a security agreement. Lenders are left to balance the risk of using specific descriptions that are incorrect or are too limited against descriptions that are so broad that either the description is insufficient under Section 9-108 or the collateral loses its identity through being joined or commingled with similar property.

There are two new exceptions to the general requirements of Section 9-108. First, a description by type is insufficient if the collateral is a commercial tort claim. Second, and perhaps more significant, a description by type is insufficient if the collateral is consumer goods or investment property and the transaction is a consumer purpose transaction. Since lenders’ counsel will likely be involved in drafting a security agreement covering a commercial tort claim, the prohibition against a general description of such collateral is unlikely to be a significant issue to lenders. Conversely, lenders must be aware of the new consumer provisions requiring specific descriptions of consumer goods and investment property collateral, since these types of transactions may be more routine and would not typically demand the immediate supervision of, or review by, legal counsel.

For certain collateral types related to real estate, additional descriptive information may be required for the security interest to attach. Under current law, if the collateral consists of crops growing or to be grown or standing timber to be cut, the security agreement must provide a description of the land on which the collateral is located. In many states, the uniform version has been amended to require this description to meet real estate filing requirements (i.e., provide a legal description instead of a “reasonable’’ description). In contrast to current law, Section 9-203(b)(3)(A) requires the additional real estate description only for the land on which standing timber to be cut is located. This is not to say a real estate description may not be used to identify growing crops and other collateral, but it is no longer required in the security agreement. Due to problems involving incorrect descriptions and the lack of any perceived utility for the description, lenders should consider discontinuing the practice of using real estate descriptions unless it is necessary to “reasonably identify’’ the collateral.

It is important to note the differences in description requirements between the security agreement and the financing statement. While “supergeneric’’ descriptions are insufficient for a security agreement, Section 9-504 specifically validates supergeneric descriptions such as “all assets’’ and “all personal property’’ in the financing statement. In addition, Section 9-502 requires real estate descriptions for as-extracted collateral and fixture filings, in addition to standing timber to be cut, on the financing statement.

CHANGES TO COLLATERAL TYPE CATEGORIES

Lenders should be aware of changes in how Revised Article 9 defines certain collateral type categories. How a collateral type category is defined under Article 9 not only affects using the category as a description, but also how a security interest in the collateral is perfected.

With respect to collateral descriptions, although Article 9 only requires that the collateral be described by category, many lenders have used and will continue to use descriptions of the general collateral categories on their security agreements and financing statements. Security agreement descriptions (and indications of the collateral on financing statements, if a lender is using the same description on both forms) should be revised to be consistent with the Article 9 definitions. The following provides some guidance on the collateral description changes.

Section 9-102(a)(2) provides an expanded definition of “Account.’’ This new definition, which is no longer limited to rights to payment for goods and services, expands the reach of accounts to include collateral that would otherwise fall within the “catch-all’’ general intangibles category under the former definitions.

Section 9-102(a)(42) continues to provide a residual, catch-all definition for general intangibles, but expressly includes payment intangibles and software. “Payment intangibles’’ are general intangibles under which the account debtor’s principal obligation is a monetary obligation. Payment intangibles are brought within Article 9 to facilitate application of Article 9 to the sale of payment intangibles. “Software’’ is defined as a computer program and supporting information provided in connection with a software transaction. If lenders use a general description for general intangibles, the description should be revised to include the specific collateral types, such as payment intangibles and software, perhaps using the definitions of those terms to explain their meaning (particularly if used prior to the Revised Article 9 effective date).

Section 9-102(a)(6) creates a new type of collateral, at least in name, called “as-extracted collateral.’’ This new collateral type is intended to create a category of collateral that is related to real estate and to which a personal property security interest attaches upon extraction. This includes minerals, oil, gas, and accounts related to minerals, oil, and gas. Although use of the new term is not required in place of minerals, oil, gas, etc., lenders may wish to incorporate this term into their descriptions.

SCOPE OF THE SECURITY INTEREST

Article 9 currently includes provisions that expand the scope of a security interest to property beyond the collateral described in a security agreement (e.g., proceeds). Revised Article 9 uses new and expanded terminology related to proceeds and supporting obligations to clarify the scope of the expanded security interest.

Section 9-102(a)(64) provides an expanded definition of “proceeds,’’ increasing the scope of a security interest in the proceeds of collateral. “Proceeds’’ now includes anything that is acquired upon the sale, lease, license, exchange, or other disposition of the collateral; whatever is collected on, or distributed on account of, collateral; rights arising out of collateral; and claims arising out of the collateral. Lenders should consider revising their security agreements to include proceeds as defined under Revised Article 9, particularly security agreements executed prior to the Revised Article 9 effective date, to expressly cover property falling within the more expansive interpretation of “proceeds.”

Section 9-203(f) expands the security interest to cover “supporting obligations.’’ “Supporting obligations’’ means letter of credit rights or secondary obligations that support the payment or performance of accounts, chattel paper, documents, general intangibles, instruments, or investment property. This codifies what was implicit under former law, but not entirely clear. A security agreement can either defer to this law, in that attachment is automatic, or refer expressly in the security agreement to the expanded scope of the security interest beyond the described collateral.

Unlike supporting obligations and proceeds, the security agreement must reference after-acquired collateral to attach to property acquired after execution of the security agreement. Section 9-204(a) does not change existing law, but continues to validate these “floating liens,’’ with some exceptions. Security agreements should continue to reference after-acquired property to effectively attach to the after-acquired property.

 

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