UCC Collateral Description: Can You Look Beyond the Four Corners of the Financing Statement?

First Midwest Bank v. Reinbold (In re I80 Equipment, LLC), 938 F.3d 866 (7th Cir. 2019) –

In connection with a lawsuit to recover a loan secured by substantially all of a debtor’s assets, a lender sought a declaration that its security interest was a properly perfected senior lien. The chapter 7 trustee countered that the security interest was avoidable based on an inadequate description of collateral in the financing statement. The bankruptcy court ruled in favor of the trustee, and the lender appealed to the Seventh Circuit.

The issue was whether the financing statement could incorporate a collateral description by reference to a separate unattached security agreement. Specifically, the financing statement covered “[a]ll Collateral described in First Amended and Restated Security Agreement dated March 9, 2015 between Debtor and Secured Party.” As explained by the court, the security agreement description included a list of 26 categories of collateral.

As usual, the courts look to applicable state law to determine whether the security interest was perfected:

  • UCC 9-502 states that a financing statement is sufficient only if it includes (1) the debtor’s name, (2) name of the secured party (or its representative), and (3) “indicates the collateral covered by the financing statement.”
  • UCC 9-504 [Indication of Collateral] states that a financing statement sufficiently indicates the collateral if (1) it “provides” a description of the collateral pursuant to UCC 9-108 or (2) indicates that it covers all assets or all personal property.
  • UCC 9-108 [Sufficiency of Description] states that a description of property is sufficient “if it reasonably identifies what is described.”
  • UCC 9-108 goes on to provide examples of reasonable identification including (1) specific listing, (2) category, (3) type of collateral defined in the UCC, (4) quantity, (5) computational or allocational formula or procedure, or (6) “any other method, if the identity of the collateral is objectively determinable.”

The Seventh Circuit characterized the issue as whether the language in UCC Article 9 requires that the description be within the four corners of the financing statement or if incorporating by reference a description in a security agreement sufficiently “indicates” the collateral.

To start with, the court contrasted the language in the current version of the UCC with that in the pre-2001 version. The pre-2001 UCC provision required that a financing statement “contain a statement indicating the types, or describing the items, of collateral,” while the current version expanded the requirements to include various approaches together with “any other method” that allows the identity of collateral to be “objectively determinable.” Thus, UCC Article 9 no longer requires that the financing statement “contain” the collateral description.

The court concluded that this relaxed approach is consistent with adopting a system of “notice filing.” It found that the ordinary meaning of “indicates” is “to serve as a ‘signal’ that ‘point[s] out’ or ‘directs attention to’ an underlying security interest. That plain reading of the text allows a party to ‘indicate’ collateral in a financing statement by pointing or directing attention to a description of the collateral in the parties’ security agreement” (footnote omitted).

An analysis of several decisions provided further support for the con clusion that the purpose of a financing statement is to put third parties on notice that the creditor has a security interest. Further, several decisions specifically suggested that incorporation by reference is an available option for describing collateral.

Thus, the question in this case became whether the reference to the security agreement was sufficient to make the collateral objectively determinable. The court concluded that incorporation of the security agreement references to “twenty-six independent categories of collateral” satisfied that criteria.

Accordingly, the lender’s UCC financing statement was adequate to perfect its security interest. So, the Seventh Circuit reversed the bankruptcy court, holding that the trustee was not entitled to avoid the lender’s lien.

Relying solely on incorporation by reference of an external security agreement collateral description is risky. What happens when the security agreement is modified? On the one hand, if the financing statement is not modified it may not track a change in collateral. On the other hand, if the financing statement collateral description is amended, that will raise the question of whether priority dates from the original UCC financing statement or the amendment. It is also not clear that all courts would agree with the Seventh Circuit. And so on.

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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