UCC Financing Statements: Words to the Wise — Do Not Allow an Active UCC to Lapse

Highland Constr. Mgmt. Services, LP v Wells Fargo, N.A. (In re Highland Constr. Mgmt. Services LP), 497 B.R. 829 (Bankr. E.D. Va. 2013) –

This opinion opens with a riddle:  “When is a financing statement that is no longer effective, still effective?”  Answer:  “When it lapses, of course!”  In this case, a secured creditor failed to file a continuation statement and its UCC financing statement lapsed during the bankruptcy.

A lender made a loan to the debtor secured by its interests in two limited liability companies.  An initial Uniform Commercial Code (UCC) financing statement was filed in late 2006.  The debtor filed bankruptcy in early 2011.  The lender failed to file a continuation statement and the financing statement lapsed in late 2011.  The sole question for the court was the effect of the lapse.

The debtor argued that when the financing statement lapsed, the lender’s claim became an unsecured claim based on the debtor’s ability to assert the rights of a lien creditor using its “strong arm” powers.  In contrast, the lender argued that the lapsed financing statement did not affect its first priority lien.

The court determined that once a security interest is perfected by filing a UCC financing statement, it remains perfected with respect to parties who held liens on the date the financing statement lapsed.  Once the financing statement lapses, the security interest is unperfected with respect to anyone who obtains a lien subsequent to the lapse.  There is an exception such that when a security interest becomes unperfected the change takes effect retroactively for purchasers for value (which includes a secured creditor) – which results in a distinction in the effect on a lien creditor as opposed to a secured lender.

The court next turned to the effect of bankruptcy on its analysis.  Noting that the Bankruptcy Code can alter the effect of state law, the court identified the bankruptcy “freeze” rule – meaning that lien priorities are generally determined as of the date a bankruptcy commences and do not change during the case (unless avoided).  The court elaborated that the general bankruptcy scheme contemplates evaluation of claims as of the commencement of the case.

In addition, as a separate matter the court noted that the “strong arm” powers under Section 544 of the Bankruptcy Code are based on the status of a lien creditor with claims at the commencement of the bankruptcy case, which again means that post-petition developments are not relevant.

After reviewing a series of cases that appeared to have inconsistent results, the court attempted to reconcile the holdings and focused on the situation where a debtor-in-possession challenges a secured creditor.  The court concluded the debtor could not avoid the security interest if the secured claim was properly perfected on the date the petition was filed.  A Section 544 avoidance action looks only at the status of claims and liens at the commencement of the case, and the results are not affected by a later lapse in perfection.  And if the “freeze” rule is applicable, priority would again be determined as of the petition date, and the secured creditor would prevail.  Consequently, the court held that the lender had a perfected security interest for purposes of determining its claim notwithstanding the post-petition lapse of its UCC financing statement.

Under an earlier version of the UCC, if a security interest was perfected at the time insolvency proceedings were commenced, the security interest remained perfected until 60 days after the insolvency proceedings terminated (or the normal five year period, if later).  This reflected the concern that filing a continuation statement would violate the automatic stay.  Consequently, a secured creditor was given protection during the insolvency proceeding and had 60 days after the case terminated to file the appropriate continuation statement.

However, the stay is no longer a concern because Section 362(b) of the Bankruptcy Code was amended to confirm that the stay does not apply to an action to continue the perfection of an interest in property that was in effect on the petition date.  Consistent with this change, the UCC was modified so that currently a financing statement will lapse if a continuation statement is not timely filed even if the lapse occurs during a bankruptcy.

Now that it is clear that a continuation statement can be filed during a bankruptcy, the clear lesson of this case is to be sure that you file a timely continuation and avoid arguments about whether your claim remains perfected.

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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