COLLATERAL DESCRIPTION BY REFERENCE

The UCC has two standards for collateral description. Section 9-108 provides that the security agreement’s “description of personal … property is sufficient, whether or not it is specific, if it reasonably identifies what is described.”  It goes on to give examples (not requirements) of reasonable identification.  However, it specifically prohibits super-generic description:

A description of collateral as ‘all the debtor’s assets’ or ‘all the debtor’s personal property’ or using words of similar import does not reasonably identify the collateral.

On the other hand, the UCC permits super generic descriptions of collateral on the financing statement.  Section 9-504 provides: 

A financing statement sufficiently indicates the collateral that it covers if the financing statement provides: (1) a description of the collateral pursuant to Section 9-108; or (2) an indication that the financing statement covers all assets or all personal property.

So the standard for a security agreement is specific while the standard for a financing statement is generic.  What if the financing statement merely provides that the collateral is what is described in the security agreement without anything further?

No problem when you get a UCC search which shows a prior lien on “all assets”.  How about if the UCC search only states that the secured party is secured in the collateral described in the security agreement?  What do you do?  Do you rely on the security agreement your prospective borrower hands over to you?  What if it had been amended to add more collateral?  And what if your intended borrower does not want you to approach the existing lender. 

Now comes a decision from the United States Court of Appeals for the Seventh Circuit (Chicago – a significant commercial center).  Yes, the situation in this decision is different from what I described above but the issue is not.  The Court indicated that the issue was

a matter of first impression for our court: Whether Illinois’s version of Article 9 of the Uniform Commercial Code requires a financing statement to contain within its four corners a specific description of secured collateral, or if incorporating a description by reference to an unattached security agreement sufficiently “indicates” the collateral.

This decision was not about a dispute between lenders as to whom held a valid interest.  It was an action by a Chapter 7 trustee against First Midwest Bank (FMB).  FMB made a loan to 180 Equipment LLC.  The security agreement contained 26 categories of collateral (e.g. accounts, goods, etc).  Instead of using the “all asset” description in the financing statement, FMB, instead, described the collateral as

[a]ll Collateral described in First Amended and Restated Security Agreement dated March 9, 2015, between Debtor and Secured Party.

When FMB brought an action against the trustee to recover almost $8 million that it claimed to be the proceeds of collateral in which it held a properly perfected and senior interest, the trustee asserted a counterclaim under §544(a) of the Bankruptcy Code, that, as a statutory lienholder, the trustee’s lien was superior to the interest of FMB because FMB did not properly perfect its interest due to its failure to provide a sufficient collateral description.  The Bankruptcy Court ruled in favor of the Trustee and the appeal was certified directly to the Seventh Circuit.[1]

The appeals court stated:

A court must view the statute as a whole, construing words and phrases in light of other relevant statutory provisions and not in isolation. Each word, clause, and sentence of a statute must be given a reasonable meaning, if possible, and should not be rendered superfluous.

The Court looked at Section 9-502, which requires that a financing statement:

(1) provide the name of the debtor; (2) provide the name of the secured party or its representative; and (3) indicate the collateral covered by the financing statement.

The Court went on:

A financing statement that substantially satisfies these requirements is effective, even if it has minor errors or omissions that are not “seriously misleading.” ….. But if a financing statement fails these basic requirements, the lender’s interests are subject to avoidance under §544(a) of the Bankruptcy Code.

It recited Official Comment 2 of Section 9-102, as follows:

This section adopts the system of “notice filing”. What is required to be filed is not, as under pre-UCC chattel mortgage and conditional sales acts, the security agreement itself, but only a simple record providing a limited amount of information (financing statement)…. The notice itself indicates merely that a person may have a security interest in the collateral indicated. Further inquiry from the parties concerned will be necessary to disclose the complete state of affairs.

The Court held that the financing statement is an abbreviation of the security agreement and concluded:

The approach … to financing statements supports the conclusion that incorporation by reference is permissible in Illinois as “any other method” under § 9-108, so long as the identity of the collateral is objectively determinable. That requirement is met here by the security agreement’s detailed list of the collateral.

* * *

The plain and ordinary meaning of Illinois’s revised version of the UCC allows a financing statement to indicate collateral by reference to the description in the underlying security agreement.

Reversed.  Success to FMB.  But what can we take away from this?

First, of course, FMB could have avoided a ton of aggravation (and legal costs) if it merely described its collateral as “all assets” on the financing statement – or even “all assets other than…” assuming its list of 26 was not intended to be all inclusive.

The more significant issue, referring back to the situation described above, is that lenders must exercise caution when intending to lend against collateral that is represented not to be part of a prior lender’s collateral package.  In such a case, and when the prior lender’s financing statement does not clearly enumerate the collateral description (as the Seventh Circuit stated), “Further inquiry from the parties concerned will be necessary to disclose the complete state of affairs.”

In other words, if the proposed borrower does not want you to communicate with the prior lender as to the nature of the collateral – and you cannot enter into a reasonable intercreditor agreement, are you that hungry to do the deal?

All of this said, I have found that financing statements filed by equipment leasing companies to give notice of their interest in their leased equipment may describe collateral by reference to the lease agreement.  In examining these leases I have, on occasion, found broad granting clauses securing the lessee’s obligations.  Without that review lenders would have found themselves subordinate to the prior filed lessor.

You may detect my distaste for descriptions of collateral by reference but, at least in the Seventh Circuit, it is sufficient and we must be guided accordingly.

In re 180 Equipment LLC, 938 F3d 886 (7th Cir, 2019)


[1] This is a process employed when the parties agree that an appeal to the District Court would be futile.

RECOVERING ON COLLATERAL – AND ITS HIDDEN COSTS

Asset based lenders lend against the value of their collateral – at least they are supposed to.  Thus, when making a loan the lender needs to consider what it will cost to recover on its collateral in order to set a reasonable advance rate.  Each type of collateral has its own issues in recovering.  Account debtors protest in paying someone other than the debtor.  Landlords deny access to inventory and equipment until the rent is paid. Even then, equipment has additional issues.  For example, we once represented a lender who wanted to take back a huge printing press that required the removal of exterior wall to a building.  We succeeded in obtaining a court order authorizing the demolition and replacement of the wall but the cost and time affected the lender’s recovery on its collateral.

Rolling stock has its own types of issues.  The 1984 film Repo Man made the repossession of rolling stock entertaining but it is far from fun – even when you have a set of keys. 

UCC 9-609 of the UCC provides:

SECURED PARTY’S RIGHT TO TAKE POSSESSION AFTER DEFAULT.

(a) Possession; rendering equipment unusable; disposition on debtor’s premises.  After default, a secured party: (1) may take possession of the collateral; and (2) without removal, may render equipment unusable and dispose of collateral on a debtor’s premises under Section 9-610.

(b) Judicial and non-judicial process.  A secured party may proceed under subsection (a): (1) pursuant to judicial process; or (2) without judicial process, if it proceeds without breach of the peace. (emphasis added).

(c) Assembly of collateral. If so agreed, and in any event after default, a secured party may require the debtor to assemble the collateral and make it available to the secured party at a place to be designated by the secured party which is reasonably convenient to both parties.

A recent decision from the United States District Court for the District of Maryland highlights how easy it is for a debtor to make out a claim for breach of the peace in a non-judicial repossession of collateral.  The plaintiffs (the debtor) purchased a dump truck financed by the lender and a dispute arose concerning payments.  When the lender’s “repo man” showed up with a tow truck, the debtor protested loudly and called the police who directed the debtor to allow the repossession.  The debtor then brought an action against the lender claiming that the repossession was in violation of UCC § 9-609 because it involved a breach of the peace.

The Court held:

Plaintiff alleges that he “objected loudly” to the repossession and claimed that Defendant “did not have the right” to repossess the truck…. Plaintiff further alleges that this disagreement “intensified” to the point that the police were called. …… Therefore, Plaintiff plausibly alleges that Defendant violated § 9-609(b).

The lender’s motion to dismiss the action was denied and even if the lender will ultimately recover its collateral, the cost to do so has gone through the roof.

The Maryland case addressed complications from recovering collateral without judicial process.  A few weeks earlier the United States District Court for the District of New Mexico addressed a judicial process to recover collateral – commonly referred to as replevin.  That case was brought ex parte – meaning that the debtor did not appear in the case.  Even so, a court will review the facts and determine whether the lender is entitled to repossess its collateral even upon the debtor’s default in responding to the claim.

Replevin was an original common-law remedy, however most states have since authorized a suit for replevin by statute. The New Mexico statute provides:

Any person having a right to the immediate possession of any goods or chattels, wrongfully taken or wrongfully detained, may bring an action of replevin for the recovery thereof and for damages sustained by reason of the unjust caption or detention thereof…  A replevin suit has two possible components: physical recovery of the collateral, and pursuit of damages for wrongful taking… . In order to obtain a pre-judgment writ of replevin, an affidavit must be filed [according to the statute] “stating: A. that the plaintiff is lawfully entitled to the possession of the property mentioned in the complaint; B. that the same was wrongfully taken or wrongfully detained by the defendant; C. that the plaintiff has reason to believe that the defendant may conceal, dispose of, or waste the property or the revenues therefrom or remove the property from the jurisdiction, during the pendency of the action; D. that the right of action accrued within one year; and E. specific facts, from which it clearly appears that the above allegations are justified”

The magistrate judge hearing the dispute broke out and applied the facts to each of the required elements that needed to be proven and went on to recommend to the District Court that it:

authorize the issuance of a writ of replevin for recovery of the collateral described in the complaint and supporting documents

But that successful ruling was not the end of the story.  Inasmuch as replevin is an equitable remedy, it typically comes with the requirement for the posting of a bond – just in case the debtor ultimately appeals and disproves what the court had granted.  In this case, the bond was to be in an amount “double the value of the collateral as described in the complaint and supporting documents”

These costs are often anticipated and even mitigated by obtaining landlord waivers.  The loan agreement should include a provision where the borrower grants the lender and its agents a license to enter the debtor’s premises (even to break locks) to repossess the collateral, which entry is specifically agreed not to be a breach of the peace.

The lesson is that it costs – and sometimes dearly – to recover on collateral and that cost needs to be factored into the amount a lender is advancing based upon the value of the collateral.  As we say time and time again: plan your divorce before you get married -be sure your loan agreements adequately provide for your recovery in the event things do not go as hoped when you made the loan.

Darren Trucking Company v. PACCAR Financial Corp., USDC Maryland, August 20, 2019, 2019 WL 3945103

Commercial Credit Group Inc. v. Protégé Excavation, Inc. USDC New Mexico, August 5, 2019 2019 WL 3973848.

MITIGATING THE COSTS IN RECOVERING ON DEFAULTED LOANS

Lawyers who represent lenders in recovering on defaulted loans are consistently confronted with the lender’s quest to recover the maximum amount at the lowest cost.  Not an unreasonable request.  However, too often the lender’s own form of agreement does not provide assistance in keeping down the costs.

In preparing this article I chose to go beyond the four corners of the judge’s decision and took advantage of electronic filing of documents (PACER) so I could see the promissory note at issue.  I was looking, in particular, to see whether a certain typical clause was included in the form but could not find it.

This case was brought against an individual to recover on two promissory notes.  Simple.

The Court ruled:

at oral argument…. the Defendant conceded that he owed the Plaintiff monies under the two Promissory Notes and that he was in default, as well. The Defendant challenged, however, the amount which Plaintiff claims to be due and owing. The Defendant consented to the entry of summary judgment as to liability but reserved the right to contest the amount of the debt at a hearing on damages. Accordingly, the Motion for Summary Judgment is GRANTED as to liability only.

The Defendant retains the right to challenge the Plaintiff’s proof as to the amount of the judgment sought and to present evidence regarding the same. A hearing to determine the Plaintiff’s damages (the amount of the judgment) shall be held….

Translated?  The bank is granted summary judgment on liability only but still needs to prove the amount owed at a separate evidentiary hearing. 

Could this “extra trial” have been avoided?

It appears (from the decision) that at the hearing on the motion for summary judgment the pro se defendant made a “bald protest” as to the amount claimed by the bank.  For whatever reason, the judge considered that sufficient to put the bank to its burden of proof on the amount owing.

Lenders typically include a clause providing that it will send monthly statements of account which statement shall be deemed to be true and correct unless timely objected to.  Thus, the statement will be deemed to be an account as stated and primary evidence in a contest as to the amount owed. 

A typical clause might read as follows:

Account Stated.  Lender’s books and records showing the account between Lender and Borrower shall be admissible as evidence in any action or proceeding, shall be binding upon the Borrower for the purpose of establishing the items therein set forth and shall constitute prima facie proof thereof.  Lender’s monthly statements setting forth the transactions hereunder rendered to Borrower whether by electronic means or otherwise shall, to the extent to which no written objection is made within thirty (30) days after the end of the month following the month of the statement, be binding upon Borrower and constitute an account stated between Lender and  Borrower and be binding upon Borrower.

A clause such as this shifts the burden of proof on the amount due to the borrower and away from the lender.  Had this clause been included in the note, the bald allegation of a dispute as to the amount would not have prevented the granting of a judgment in an amount certain and would have avoided the necessity of additional proceedings, which likely will include discovery and court appearances, all of which run up the cost of litigation.

Lending money is easy.  Getting it back is not.  That is why we fill up so many pages of a loan agreement.  Plan your divorce before you get married.

TD Bank, N.A. v. Michael C. Culver, 2019 WL 2579232

ARE MCAs FINDING THEMSELVES SUBJECT TO CLOSER SCRUTINY?

In November, 2018, I published an article in the ABF Journal entitled Why Are MCAs Doing So Well in the Courts?  First, let’s agree that there are many MCA providers that practice within the scope of what is fair, reasonable and legal.  Those MCA providers tend to view the growing number of unscrupulous MCA providers as being damaging to their growing lending niche.

With few exceptions, MCAs have fared well in the courts.  A very recent decision from the United States District Court for the Eastern District of Pennsylvania may be an indication that things may be changing.

In this case the plaintiff asserted claims for violations of the federal Racketeer Influenced and Corrupt Organizations Act (RICO) and Texas law against Defendants Complete Business Solutions Group, Inc. (CBSG), Prime Time Funding, LLC (PTF), and unnamed John and Jane Does.  Plaintiffs asserted that the Defendants worked together to exploit cash-strapped small businesses by luring them into endless cycles of usurious debt under the guise of false promises of consulting services and debt reduction.

The plaintiff (Fleetwood Services) ultimately received a traditional small business loan that it used to repay Defendants in full, including what Plaintiffs characterize as an undisclosed annualized percentage rate of interest at 114.07%.

The defendants brought a motion to dismiss the complaint.  In its decision denying the motion, the Court described the relationship between the parties as follows:

The relationship between Plaintiffs and CBSG was governed by the terms of the “Factoring Agreement,” which … obligated CBSG to provide Fleetwood Services with $370,000 (the Purchase Price) allegedly in exchange for $547,000 worth of Fleetwood Services accounts receivables (the Receipts Purchased Amount)…. However, allegedly unlike a traditional factoring agreement, the fair market value of the accounts receivable (i.e., the Receipts Purchased Amount) was unilaterally dictated by CBSG and based upon the creditworthiness of Fleetwood Services—not the creditworthiness of the customers who were to pay the accounts receivable or any appraisal of the actual value of Fleetwood Services’ accounts receivable…. The Factoring Agreement obligated Fleetwood Services to repay the Receipts Purchased Amount in 110 daily installments of $5,000.25, which were effectuated by electronic automated clearing house debits from Fleetwood Services’ Texas-based bank accounts. These daily payments were, like the Receipts Purchased Amount, also divorced from Fleetwood Services’ actual accounts receivable because the Factoring Agreement made “any and all receivables from any customer in any amount based on any sale subject to Defendant CBSG for payment of the daily fixed debit.

The Factoring Agreement also provided for (1) a declaration that the money provided by CBSG to Fleetwood Services “is not intended to be, nor shall it be construed as a loan”; (2) CBSG’s promise to refund Fleetwood Services any amount greater than the maximum lawful interest rate, in the event “a court determines that [CBSG] has charged or received interest” under the Agreement; and (3) a Pennsylvania choice of law provision.

Along with the Factoring Agreement, the Defendants also required Fleetwood Services to ensure repayment by granting CBSG security interests in “all accounts, chattel paper, documents, equipment, general intangibles, instruments and inventory…now or hereafter owned or acquired by [Fleetwood Services] and (b) all proceeds, as that term is defined in Article 9 of the UCC”, and obligating the owners to personally guarantee that Fleetwood Services paid CBSG the Receipts Purchased Amount ($547,000).

The Court stated:

Before the Court can address the Defendants’ arguments, it must first characterize the Factoring Agreement. If the Factoring Agreement is in substance a factoring agreement, i.e., a purchase of accounts receivable below their face value, then there can be no usury….If the Factoring Agreement functions as a loan, however, the Court must …determine whether it is subject to the usury laws of Pennsylvania or Texas, as the Agreement calls for the application of Pennsylvania law but the Plaintiffs assert Texas law applies…

The Court went on to rule (only for the purposes of the motion to dismiss) that the Factoring Agreement was not a “true factoring agreement” and, thus, was a “loan” subject to the usury laws of Texas which has a rather harsh usury law.

What glares out the most from this decision is the Court’s characterization of the MCA industry:

CBSG and PTF are engaged in the merchant cash advance industry, which is the merchant-to-merchant equivalent of consumer pay-day lendingan industry allegedly notorious for its predatory practices and extremely high interest rates.

Whether this case will spark closer scrutiny of providers of merchant cash advances is yet to be seen.  Those MCA providers that offer “true sale” factoring and/or rates that are reasonable based upon the credit risk being taken and below any usury limit will have nothing to fear and will likely benefit from those less scrupulous providers being punished for their greed.

Fleetwood Services, LLC v Complete Business Solutions Group, Inc. doing business as Par Funding, 2019 WL 1558087 (April 10, 2019, EDPA)

A DISCRETIONARY FILING MIGHT HAVE SAVED THIS ASSIGNMENT OF PAYMENT

From time to time a lender may find itself holding funds that are not its property and to which multiple parties claim an interest. The lender does not want to be accused of exercising control over those funds (conversion), but does not want to take the risk of delivering the funds to the wrong person and remaining at risk of having to pay the “wronged” party. That is the purpose of an interpleader action – to implead (deposit the funds into court for a determination of who is entitled to them. Interpleaders may be used to dispose of funds (defensive) or to recover funds. For example, imagine you have placed account debtors on notice and the “bad guy” borrower is disputing your entitlement to the funds and pressuring the account debtor to pay him. You can bring the interpleader action to force the account debtor to deposit the funds in court.

An interesting interpleader case recently came down from the California Court of Appeal involving proceeds from the award winning Broadway musical, Million Dollar Quartet (MDQ). The question in this interpleader action was which adverse claimant was entitled to the impleaded funds: a judgment creditor with a properly recorded judgment lien, or an assignee who did not file a financing statement with respect to distributions irrevocably assigned to it by the judgment debtor before the judgment lien was recorded.

The appellate court determined that the answer depended on whether under California’s Uniform Commercial Code the assignment created a security interest that had to be perfected (but was not) by the filing of a financing statement. The court then determined that the trial court was correct in holding that although the assignment created a security interest, the judgment creditor was entitled to the impleaded funds because its recorded judgment lien had priority over the unperfected security interest.

The interpleader action followed a prior action brought by Cleopatra Records as an investor in the development of the MDQ musical which prior action ultimately resulted in a judgment in favor of Cleopatra. Prior to the entry of the judgment, the author of the musical (one of the judgment debtors) assigned part of his interest in future distributions from the production of the musical to the law firm that represented the defendants in the lawsuit. The trial court in the interpleader action ruled that the assignment constituted a “security interest” that was subject to (UCC) perfection by the filing of a financing statement inasmuch as the transaction did not involve real property and because the assignment was of a percentage of the interest in future distributions that would revert to the debtor once the debt to the law firm was paid.

The law firm argued that the transfer was an absolute assignment. However the court dismissed that claim because the assignment reverted back once the firm’s fees had been paid and because the assignment was not for the full amount of the asset.

The appellate court held that because the law firm did not file a financing statement, Cleopatra’s judgment lien had “priority in time of filing or perfection”of the unperfected assignment to the law firm.

Two worthwhile takeaways from this case:

  1. Although there are other legal theories the law firm might have pursued the lesson from this case is clear: When in doubt file. A prophylactic filing could have saved this law firm the trouble and aggravation it put itself through.
  2. When holding funds in which you do not have an interest and which are subject to multiple claims, implead the funds by bringing an interpleader action. The court awarded MDQ its attorneys fees and costs, which the court directed were to be deducted from the impleaded funds. Thus, there was no loss for doing the right thing and at the same time demonstrated MDQ’s clean hands in not retaining possession of the funds.

MDQ, LLC et al. v Gilbert, Kelly, Crowley & Jennett LLP, Court of Appeal, Second District, Division 8, California. 2019 WL 948726.