Perfection Takes The Right Amount of Time

Imagine that you are a banker sitting at your desk. The phone rings and it's an attorney on the other end of the line who you regularly engage to document, negotiate and close commercial loans for you and your bank. “We’ve got a problem” says the attorney, “one of the secured loans that we handled for you is no longer secured.”

After you wipe the sweat off your brow that has quickly developed from hearing that news, you question how that could have happened. After all, you know that your bank’s UCC-1 financing statement was properly filed against your customer in the appropriate filing office and that your bank has internal controls to prevent the mere lapse of the UCC-1 financing statement after 5 years from the filing date (typically by filing a UCC-3 continuation statement).

Regrettably, that scenario seems to be playing out more frequently than ever before. Why is that? Well, more and more companies are converting their entity type – typically from a corporation to a limited liability company – for tax-saving or liability-protection purposes. Others are moving from one state to another or they are re-organizing their entity under the laws of another state. And then there are those companies who simply change their name to further their business objectives. On its face, these situations are innocuous at best and invariably undertaken without any intent by a borrower to cause potential harm to its banking relationship. Below the surface, however, they all result in a UCC-1 perfected security interest becoming unperfected in certain circumstances, or ineffective as to certain collateral in other circumstances, UNLESS (i) certain loan covenants are included in your loan documentation, (ii) your customer observes the requirements of those covenants and (iii) steps are taken by or on behalf of the bank in a timely manner to preserve the effectiveness of the initial UCC-1 financing statement filing.

Every loan agreement or security agreement governing a loan secured by UCC-type collateral (such as accounts, documents, contracts, equipment, inventory, general intangibles, tangible property and investment property) should contain covenants requiring the grantor to maintain its existence and not change its name or state of incorporation/formation, nor change its organizational documents, without the prior written consent of (or, at a minimum, prior written notice to) the bank. Assuming that the bank gets notice of a change in entity type and/or change in the name of a grantor either before or promptly following the occurrence of such event, the bank will have up to 4 months to preserve the effectiveness of its existing UCC-1 financing statement for collateral acquired or arising after the expiration of the 4-month period by filing a UCC-3 amendment (in the case of a name change or change in entity type, which customarily includes a change in the company’s name, such as ABC Company, Inc. to ABC Company, LLC – and, albeit subtle, that change would likely render the original UCC-1 financing statement filing ineffective with respect to any collateral acquired by the company or arising after 4 months) or by filing a new UCC-1 financing statement in the new jurisdiction (in the case of a change in the state of formation/incorporation). Consider how the mere change in a company’s name could readily impact a bank’s lien on accounts receivable. During any given year, a company continuously generates new accounts receivable in the ordinary course of its business. If a company changes its name and the bank does not file a UCC-3 amendment to reflect the company’s change in entity type and/or entity name within 4 months of the change occurring, the bank will lose its perfection as to any accounts receivable arising after the expiration of that 4 month period. It will, however, retain its perfected security interest with respect to any previously existing collateral as long as the existing UCC-1 financing statement has not become materially misleading by the name change. If a company changes its name from ABC Company, Inc. to XYZ Company, LLC, the existing UCC-1 financing statement filing would likely be deemed materially misleading and, therefore, even lose its effectiveness of perfecting the bank’s lien position as to any previously existing collateral AND any newly acquired collateral.

So, the next time you learn of a borrower or loan obligor (who has granted to your bank a security interest in UCC-type collateral) undergoing a name change, a change in entity type or a change in its state of formation/incorporation, promptly reach out to your attorney to ensure that your bank’s perfected lien position on collateral remains as such. Simply put, perfection takes the right amount of time.

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