Priority Fight: Equipment Vendor Takes On Mortgagee

MTGLQ Investors, LP v. Bresco Solutions, LLC (In re Marvel Cliff Crossing Apartments, LLC), 484 B.R. 175 (Bankr. S.D. Ohio 2012) –

In Marvel Cliff, an equipment vendor sold and installed security cameras and wireless internet access equipment together with related hardware at an apartment complex.  The vendor filed UCC financing statements with the secretary of state’s office, but did not file fixture filings with the local county recorder’s office.

The mortgagee claimed that it had priority because the equipment vendor did not perfect by filing a county fixture filing, while the equipment vendor contended that it had properly filed and was entitled to priority based on its purchase-money security interest (PMSI).  State law determines the nature and extent of a security interest in the debtor’s property.  In this case, that meant the Uniform Commercial Code (UCC).

The mortgagee had a security interest in the collateral that was perfected before the equipment vendor perfected its interest.  Although generally the first person to perfect has priority, a purchase money security interest – meaning a lien to secure the purchase price of the collateral –has priority, even over previously filed interests.  To be senior, the PMSI must be perfected before the debtor receives possession of the collateral (and, in the case of inventory or livestock, a timely notice must be given to senior creditors).

As a threshold matter, the equipment vendor had to establish that the debtor granted it a security interest in a written security agreement.  The purchase agreement for the security cameras included a specific statement that “Buyer grants Security Interest in onsite existing DVR Security System …”.  The internet access equipment was less clear since the purchase agreement did not address the issue, while the servicing agreement stated “customer will sign a note for the purchase price and grant a security interest in the equipment installed.”  However, the court found that the documentation was sufficient to grant a security interest in both cases.

The next issue was whether the equipment constituted fixtures after installation the apartment complex.  Under the UCC, a security interest in “goods” is perfected by filing a financing statement with the secretary of state, while a security interest in “fixtures” is perfected by filing a financing statement with the county recorder’s office.  Since the equipment vendor did a state filing, but not a county filing, its claim to priority turned on whether the equipment had become fixtures.

Under state law, a fixture was defined as “goods that have become so related to particular real property that an interest in them arises under real property law.”  State courts weighed three factors:  (i) actual attachment to the real property, (ii) appropriation of the personal property to the use or purpose of the real property, and (iii) the intention of the parties.  Use and intent are considered the most important.

The security cameras were attached “merely by screws” and were removable.  Other parts of the system were attached to a free standing rack.  Since (i) the collateral was removable with little or no harm to the property, (ii) the items were not integral parts of the real estate but rather benefited the business conducted on the property as opposed to the property itself, and (iii) the parties did not intend for the items to become fixtures, the court determined that the vendor’s collateral was goods, not fixtures.

Surprisingly, the court also went on to note that, even if the vendor’s security interest had not been perfected, it would have been entitled to secured status under the doctrine of marshaling.  This doctrine is relevant when a senior creditor has a lien on two groups of assets, while a junior only has a lien on only one of the groups.  Basically the senior lender may not exercise its rights so that it will be satisfied to the exclusion of the junior creditor.  (See discussion in Marshaling Assets: Variation on a Theme.)

Since the mortgagee had a claim valued at ~$31.7 million secured by real property valued at $32.5 million in addition to the collateral covered by the vendor’s security interest, the court indicated that the mortgagee could have been required to first satisfy its claim from the real property, before reaching the equipment vendor’s collateral.

After disposing of a few additional ancillary issues, the court concluded that the equipment vendor had a perfected purchase money security interest that was senior to the mortgagee’s liens.

This case illustrates that a mortgagee may get a rude awakening when it finds out that other creditors have claims to elements of its collateral that turn out to be senior.  It should carefully evaluate any items that might be classified as personal property (for example, refrigerators and other appliances in an apartment complex).  If those items are subject to seller financing, and the seller has a filed UCC financing statement, the mortgagee’s interests may be junior even though the mortgagee recorded a UCC financing statement first.  As further illustrated by this case, even items that appear to be part of the real estate, such as a security system, may be subject to this risk.

Vicki R. Harding, Esq.

About BankruptcyRealEstateInsights

Vicki R. Harding was a partner in the Detroit office of Pepper Hamilton LLP who moved to Arizona seeking warmer weather. Ms. Harding continues to handle commercial transactions with an emphasis on real estate and bankruptcy issues (but no longer owns a snow shovel).
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