Most trade creditors are familiar with the Uniform Commercial Code’s article 9 that deals with secured transactions. Article 9 describes how a lender can become a secured creditor and “perfect” or establish priority over other secured creditors in the event their debtor defaults.
Uniform Law Commissioner Edwin E. Smith, who chaired the committee that drafted the article 9 amendments currently being adopted or introduced in state legislatures, says article 9 creates an “efficient system” to take a security interest in personal property, such as equipment, inventory or accounts receivable, to secure a loan or other obligation. “Article 9 has a very functional definition of what a security interest is.”
“It sets forth the legal rules for how a lender or other secured creditor can obtain an enforceable interest against the personal property, what we call a security interest,” Smith says. “It tells you how that interest can stand up and be superior to the interest of a creditor who is unsecured. That’s what we call perfection. That’s important because the trustee in bankruptcy has the hypothetical status of a creditor who has obtained a lien.”
To become a secured creditor, a lender should:
- Prepare a security agreement that describes the collateral and have the debtor authenticate it.
- File a financing statement or UCC-1 form with the appropriate secretary of state’s office.
- Identify and notify other secured creditors within in a predetermined time frame associated with whether the goods are classified as inventory or equipment.
To learn if other secured creditors have filed financing statements, lenders search the appropriate state’s database where financing statements are stored. A secured creditor searches the UCC records to see if anyone else has filed a financing statement covering the collateral of the company (borrower). It is very important to a secured creditor that they be in a first filing position on the collateral of their loan. If there is ever a liquidation or bankruptcy, the first secured creditor who filed a proper UCC1 will be paid out first.