June 23, 2001
LENDER UPDATE: JUNE 15, 2001
Vermont Legal Issues for Banks and Other Lenders
SURVIVING THE TRANSITION TO REVISED ARTICLE 9
By: Andre D. Bouffard and William J. Dodge
INTRODUCTION
The world of secured lending is about to change. As of writing, thirty-nine jurisdictions (including Vermont, New Hampshire, and Maine) had passed and twelve other jurisdictions (including Massachusetts, and New York) were in the process of passing a major revision to Article 9 of the Uniform Commercial Code. 'Revised Article 9' or 'RA9', as it has come to be known, goes into effect on July 1, 2001. Significant changes have been made to the types of transactions and property covered by Article 9, as well as the rules for creating, perfecting, and enforcing Article 9 security interests. The biggest practical impact is to change the rules on the place for filing financing statements, but there are changes that will impact nearly all aspects of secured lending. Because RA9 makes so many important changes to the law of secured financing, it will affect transactions entered into prior to the effective date of the new law. How the changes in the law will affect existing secured transactions is determined by a detailed and complex scheme of transition rules. The full scope of those transition rules is beyond the scope of this Lender Update. The purpose of this article is to highlight some of the key issues raised by the transition rules in some of the more common transactions, and point out some actions secured lenders can take to protect against loss of security in the transition to RA9. Next month, we will issue a second Lender Update discussing the impact of the transition to RA9 on priority and foreclosure of security interests, and how the transition rules will work in more complicated situations.
STAYING PERFECTED THROUGH THE TRANSITION: FILING AND CONTINUING FINANCING STATEMENTS
Generally, current Article 9 requires lenders to file financing statements in a local or state office of the state in which tangible collateral is located, and in the state of the debtor's chief executive office for intangible collateral. Under RA9, most financing statements will need to be filed with the Secretary of State's office of the state in which the debtor is located. For an entity created by registering with a state, the debtor's location will be that state. If the debtor is unregistered, the debtor will be located in the state in which it keeps its head office. Individual debtors will be considered "located" in their place of principal residence.
RA9 creates a five-year transition rule for security interests perfected by filing under current law. Thus, any financing statement or continuation statement filed prior to July 1, 2001 remains valid until five years after the filing date or July 1, 2006, whichever occurs sooner. Where the place for filing a financing statement is the same under both current law and the revision, the old-act financing statement (an "OA9 statement") may be continued only by filing a continuation statement in that office complying with the requirements of RA9. If the proper place for filing has changed under RA9, then a new "initial financing statement in lieu of a continuation statement" ("IFS/CS") must be filed in the proper new state under RA9, in order to continue the filing. The IFS/CS may be filed at any time, but it must be filed no later than the normal continuation deadline. An IFS/CS must comply in all respects with RA9, and, in addition, it must specifically contain the following information concerning the OA9 statement:
If the filing of an IFS/CS is necessary to continue the effectiveness of the OA9 statement, the signature of the debtor is not needed. Proper filing of an IFS/CS will maintain the secured party's perfected status back to the date of the OA9 filing. An IFS/CS has a life of its own and must itself be continued within five years of its filing date.
It is not necessary to attach copies of the OA9 financing statements and continuation statements to an IFS/CS. However, the old filings will be discarded by the original filing office after six years. To preserve evidence of the OA9 filings, in case there is any future priority dispute, the secured party should retain copies of those filings.
It does not appear that all 50 states will enact RA9 by the uniform effective date of July 1, 2001. As a result, it will be necessary for secured creditors to continue OA9 financing statements in states that have not adopted RA9, until those states have converted to the new law. In transactions involving multi-state collateral, the creditor will need to determine if all the involved states have adopted RA9 before determining the proper means for continuing all financing statements in that transaction.
The 5-year transition rule applicable to financing statement filings helps secured lenders by giving plenty of time to comply with the new law, but also complicates the work of searching for filings by other secured parties in connection with loan modifications and new transactions. OA9 financing statement filings in jurisdictions other than the debtor's location can remain effective for up to 5 years after July 1, 2001. This means that a search for filings against the debtor, until July 1, 2006, will have to cover all possible old filing locations and the new location.
TRANSITION PROBLEMS IN NON-FILING TRANSACTIONS:
THE ONE-YEAR RULE
For certain secured transactions closed under the existing version of Article 9, where perfection has been accomplished through some method other than filing, or where the secured transaction was outside the scope of existing Article 9, lenders will need to take some action within one year to avoid losing perfected status. For example, while deposit accounts will be covered by RA9, they are outside existing Article 9. Under existing law, secured lenders with deposit accounts as collateral generally perfect via a common law pledge. Now secured lenders will be required to obtain control over deposit accounts under a detailed set of rules set out in RA9. Other examples of collateral that are covered by RA9 but were previously outside Article 9 are health care insurance receivables, commercial tort claims, certain security interests created by governments and governmental units, and certain letter of credit rights.
RA9 specifies the rules by which a secured lender can perfect a security interest in these new types of Article 9 collateral. If a secured lender has perfected a security interest in any of these forms of collateral prior to July 1, 2001, it must comply with the RA9 perfection rules by June 30, 2002, to maintain its perfected status. Using deposit accounts as an example, the secured lender will have one year after July 1, 2001, to obtain control over any deposit account it holds as collateral, per RA9 requirements, or it will lose its perfected status. The methods of perfection vary for different types of collateral, so the action needed in each situation depends on the particulars of RA9.
Even if a secured transaction was completed under existing Article 9, action may be necessary within one year to maintain perfection due to changes in the Article 9 perfection rules. The primary example of this is where collateral is in the possession of a bailee, such as a warehouse, and the creditor has perfected under existing Article 9 by notifying the bailee of its security interest. RA9 imposes a stricter perfection requirement: the bailee must now sign or authenticate an acknowledgement that it holds the collateral for the secured party's benefit. Under the transition rules, the acknowledgement must be obtained within one year to maintain perfection.
Certain problems with collateral descriptions can also require action within one year to avoid losing perfected status. The primary example of this is security agreements in consumer transactions that have general "collateral type" descriptions such as "all goods" or "all securities accounts." Under RA9, these collateral descriptions are not specific enough in consumer transactions to create an enforceable security interest. Within one year of the effective date, the secured lender must obtain a new or amended security agreement with a more specific collateral description meeting the RA9 standard, or the security interest becomes unenforceable.
LOAN RENEWALS AND MODIFICATIONS: AN OPPORTUNITY TO SOLVE PROBLEMS
The changes made by RA9 render pre-effective date security agreements in some respects obsolete. RA9 makes some significant terminology changes, and recharacterizes certain types of collateral. One example of an important terminology change is the expansion of the definition of "accounts," which now includes rental and license fees as well as other rights to payment not previously covered by the definition. Under current law, these items are "general intangibles." A secured lender may want to make sure that it has a security interest in all types of payment rights within the broader definition of "accounts" under RA9, but its pre-effective date security agreement may not achieve this objective, particularly if the agreement's definitions are tied to current Article 9.
An event such as a loan renewal or modification is an ideal time to address this type of documentation issue, and make sure that the lender's security interest extends to all collateral the lender desires. With some careful attention to the definitional provisions of security agreements, these issues can be effectively addressed. Secured lenders should consider a review of existing security documents to bring them up to date with RA9 whenever secured loans come up for renewal or are under consideration for modification.
Sometimes these issues can be addressed at the time of continuation of existing financing statements. For example, if the OA9 financing statement listed general intangibles in order to cover license and/or rental fees, but did not list accounts, the security interest in the license fees or rental fees would lapse after the fifth year. To avoid this result, the collateral description in the financing statement could be amended at the time of continuation to list "license fees" or "rental fees."
TO RECAP
RA9's transition rules are designed to give secured lenders adequate time to perform the steps needed to maintain the perfected status of security interests obtained in pre-effective date transactions. The rules are complex because of the terminology changes, the new rules pertaining to place of filing, and the transition rules for bringing transactions covered by existing Article 9 up to speed with the new law.
While the change to the rule on the place of filing simplifies the filing process for new transactions, it complicates the UCC searching process by requiring dual searches for the duration of the transition period. This change also complicates the process for continuing financing statements where the place of filing under RA9 is different than the place of filing under existing law. While no immediate action is needed in the vast majority of cases to protect existing security interests, careful attention to the rules on continuation will be necessary to avoid losing perfection.
Transactions covered by the one-year transition rule will require more prompt action. Secured lenders need to identify those transactions that may be adversely affected by this rule and act accordingly.
Lenders should also use loan renewals and modification transactions as an opportunity to address outmoded documentation, and improve their security position where possible.
One last note: Because all 50 states are not likely to enact RA9 by July 1, 2001, the already complex transition rules will be further complicated because different states will be operating under different laws. Serious conflict-of-laws issues may arise for transactions involving the law of states that have not enacted RA9. Those issues are beyond the scope of this article, but will need to be addressed by secured lenders and their counsel.
Andre Bouffard is chair of Downs Rachlin Martin's Commercial Finance and Bankruptcy group, and William Dodge is a director practicing in the group. DRM attorneys represent lenders in Loan Origination, Regulatory Matters, Loan Restructuring and Work-Outs, Collection and Foreclosure Litigation, Bankruptcy Matters, and Lender Liability Litigation. For more information, contact Andre Bouffard.
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