The UCC frequently requires financing statements to perfect the security interests of lenders in collateral granted by the borrower. Financing statements provide notice to third parties and bankruptcy trustees of the existence of the security interest. One of the key requirements of a financing statement is that it contains an adequate description of the collateral.
Recently, the United States Court of Appeals for the Sixth Circuit ruled that a lender's security interest in accounts was not perfected and thus not entitled to priority, because the lender's financing statement did not include the word "accounts" in its description of the collateral. See 1st Source Bank v. Wilson Bank & Trust et al., 735 F.3d 500 (6th Cir. 2013). The lender's security agreement described the collateral as equipment, accounts, and the proceeds from the collateral. The financing statement identified the collateral as equipment and "all proceeds thereof, including rental and/or lease receipts." The financing statement failed to mention accounts. Applying Tennessee law, the Court stated that "revenues earned through the use of collateral are not proceeds" and the proceeds from the accounts receivable were not subject to the lender's collateral for purposes of priority since accounts were not identified. Thus, the junior lenders who, with respect to the borrower's accounts and related proceeds, had listed "accounts" or "accounts receivable" in their financing statements held priority over the lender who filed its financing statement earlier in time.
The Court's holding has bankruptcy implications as well. Since the Bankruptcy Code does not define proceeds but relies upon state law, the definition of proceeds developed by the Sixth Circuit could be used to determine whether a pre-petition security interest extends to certain post-petition property. A narrow view of the definition of proceeds may limit the ability of the lender to enforce its security interest in a bankruptcy case of the borrower as it relates to proceeds.
The relevant Texas UCC sections governing perfection and priority are identical to the Tennessee UCC sections. Although the Sixth Circuit did not agree with the lender's interpretation of the UCC extending the broad definition of "proceeds" to include accounts, there are several sections in the UCC that may provide the lender with relief. For instance, section 9-315 provides that if a lender has a perfected security interest in inventory, it would also have a perfected security interest in an account as proceeds of the inventory.
The Sixth Circuit apparently did not consider these sections which provided a basis to argue for perfection in proceeds of collateral in an account although it is not identified possibly because the lender did not claim a lien in inventory. Regardless, lenders should take heed of the Sixth Circuit ruling and make certain that the collateral description in the financing statement matches the collateral description contained in the security agreement. Failure to do so may subject the lender to a priority fight that results in a loss of its ability to enforce its security interest in bankruptcy.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
