No Fraudulent Conveyance Despite Transfer of Assets After Notice of Default to Guarantor

In a Sept. 29, 2020, decision, the Eleventh Circuit Court of Appeals issued a disturbing decision affirming dismissal of a bank’s action to bar a guarantor’s bankruptcy discharge despite the guarantor having transferred substantial assets to a limited liability company he set up for his wife and daughter. The transfer occurred after the default by the borrower.

The non-dischargability action was dismissed by the Bankruptcy Court for the Southern District of Alabama, and was later affirmed by the United States District Court. The bank then appealed to the Eleventh Circuit (the appellate court just below the United States Supreme Court), which covers the states of Georgia, Alabama and Florida.

The guarantor guaranteed two business loans made in 2006 to fund a real estate development project. In 2008, he reaffirmed his guaranty when the loans were increased. A year later, the development project was in financial trouble and the bank sent the guarantor a warning of potential default. Less than two weeks after receiving the warning letter, the guarantor conveyed parcels of real property to a newly formed limited liability company whose members were the guarantor, his wife and daughter. He later conveyed his membership interest to his wife and daughter, fully divesting himself of any interest. This transfer was part of a series of conveyances of personal assets including real property, cash and business interests made to family members over the next five years. In 2010, the bank brought an action against the guarantor resulting in a money judgment in the amount of $9.1 million. The guarantor continued to transfer assets through 2014.

The bank (by its successor) ultimately sued the guarantor, his wife and daughter under the Alabama Uniform Fraudulent Transfer Act resulting in the guarantor filing for bankruptcy. The bank then commenced an adversary proceeding to declare the guarantor exempt from discharge due and allege the fraudulent conveyance. The guarantor answered the complaint and then moved for summary judgment dismissing the complaint by arguing that he did not defraud the bank in guarantying the loans, and because his conveyances did not injure the bank or its property.

The Bankruptcy Court found that the bank’s claim failed because the bank did “not contend that the underlying debt from the guaranties was obtained by fraud or was anything other than a standard contract debt” and because “[t]he underlying debt is the result of personal guaranties, not any willful and malicious injury by [guarantor].” Finally, the Bankruptcy Court found no basis for the bank to amend its complaint to add a claim under the Fraudulent Transfer Act, noting that the bank had “not provided any Alabama law that [a] debtor/transferor who fraudulently transfers property is liable to a creditor for the value of the transferred property.” On appeal, the District Court agreed with the Bankruptcy Court “for all the reasons articulated in [its] order,” and the bank appealed to the Eleventh Circuit.

The Eleventh Circuit stated that the bank

does not—and cannot—argue that [guarantor] or the entity whose debt he guarantied fraudulently obtained money or property from [the bank].  A state court awarded [the bank] a judgment on its ordinary breach of contract claim, and that judgment makes no findings of fraud. The only fraud that [the bank] alleges—[guarantor’s] conveyances of real and personal property—happened years after [guarantor] incurred the debt by signing the guaranties. The money that the bank loaned is obviously not traceable to those later conveyances.

It went on to distinguish the 2016 decision of the United States Supreme Court in Husky International Electronics, which held “[t]he term ‘actual fraud’ in § 523(a)(2)(A) encompasses forms of fraud, like fraudulent conveyance schemes, that can be effected without a false representation.”

However, the Eleventh Circuit claimed that

…the Supreme Court [did not] eliminate[] the requirement that for a debt to be exempt from discharge …, the money or property giving rise to the debt must have been “obtained by” fraud, actual or otherwise. Instead, [it] merely recognized the possibility that fraudulent schemes lacking a misrepresentation—including fraudulent transfers of assets to avoid creditors—can satisfy the “obtained by” requirement in some circumstances.

Readers of cialis pharmacy sell which simile al viagra ma senza ricetta civilization interpretive essay assignment viagra holland examples of essays for high school essay on democracy in modern india essay on role of youth in modern india econometric thesis topics essay about my family members research paper outline sample turabian nolvadex for gyno prevention mfa creative writing programs spring admission literature reviews in research papers essay about sectionalism will you do my homework for me introduction to a essay generator source url cs402 midterm solved papers essay introduction yourself examples watch click here essay on corruption free india thesis farm maryland heights mo best annotated bibliography ghostwriters service for masters source get link here WurstCaseScenario likely understand how difficult it is to prove intentin order to succeed in proving “actual fraud.” But a fraudulent conveyance does not need to be done with intent to defraud. It is the action that matters – not the reason for it.

Section 8-9A-4 of the Uniform Fraudulent Transfer Act, as adopted in Alabama, provides:

(a) A transfer made by a debtor is fraudulent as to a creditor, whether the creditor’s claim arose before or after the transfer was made, if the debtor made the transfer with actual intent to hinder, delay, or defraud any creditor of the debtor.

This type of fraudulent transfer does require proof of intent. Although, in its complaint, the bank used some of this language, it did not make any reference to this Alabama state law. Instead, it only referred to Section 523 of the Bankruptcy Code, the section that addresses exemptions to discharge. In addition, Section 8-9A-5 of the Uniform Fraudulent Transfer Act, as adopted in Alabama, provides for certain transfers that do not require proof of intent to defraud:

(a) A transfer made by a debtor is fraudulent as to a creditor whose claim arose before the transfer was made if the debtor made the transfer without receiving a reasonably equivalent value in exchange for the transfer and the debtor was insolvent at that time or the debtor became insolvent as a result of the transfer.

(b) A transfer made by a debtor is fraudulent as to a creditor whose claim arose before the transfer was made if the transfer was made to an insider for an antecedent debt and the debtor was insolvent at that time and the insider had reasonable cause to believe that the debtor was insolvent.

These claims were not included in the complaint although it would appear likely that they could have been proven.

Section 523 of the Bankruptcy Code, which the bank did specifically cite in its complaint, does not provide for fraudulent conveyances. Inasmuch as the bank did not ask to set aside the transfer under Alabama law, the Court did not have to address whether the transfer would be exempted from discharge. It merely needed to deny the relief under Section 523.

Had the Eleventh Circuit stopped there, it might not have been so bad. Instead, it went beyond the failure to prove intent under 523:

The only misconduct alleged by [the bank] pertains to [guarantor’s] fraudulent conveyances of assets. But those conveyances occurred years after [guarantor] became indebted to [the bank] for the [borrower’s] guaranties, and the conveyances are not traceable to that debt, which arose from an ordinary breach of contract.

That is what should concern lenders. This makes it unclear whether Alabama and the Eleventh Circuit will protect lenders against fraudulent transfers by its borrower and guarantors when a well-pled complaint is at issue, instead of the one in this case, which clearly failed to put forth the proper claims.

SE Property Holdings, LLC  v. Jerry DeWayne Gaddy, 11th Cir., September 29, 2020 (2020 WL 5793082)



As we remain glued to the national and local news about return-to-work procedures and the effects that the pandemic has had on the worldwide economy, we take a look at an interesting decision that just came down from the Bankruptcy Court for the Western District of Tennessee.

The individual debtor filed his voluntary petition in December 2019. An operating trustee was appointed who asserted that as trustee he stepped into the debtor’s shoes as the shareholder of the debtor’s businesses. Alpha Visions Learning Academy, Inc. (Alpha), one of the debtor’s businesses, is a childcare center with 20 employees and about 70 children attending. As a result of the COVID-19 pandemic, attendance dropped and the trustee applied to the Small Business Administration (SBA) for a loan under the Paycheck Protection Program (PPP).

The trustee brought a motion and complaint seeking entry of a temporary restraining order, preliminary injunction and permanent injunction directing the SBA to consider Alpha’s PPP application without consideration of the debtor-owner’s bankruptcy proceedings. In addition, Alpha sought a declaration that SBA violated the Administrative Procedures Act and 11 USC Section 525(a) in excluding applications from entities who are in bankruptcy or who have an owner in bankruptcy.

The trustee alleged that the SBA made approval of any PPP loan expressly contingent on the applicant or any owner of the applicant not being “presently involved in any bankruptcy,” even though this condition is not articulated in the CARES Act that enacts the PPP, or in the Small Business Act. The trustee relied upon Section 525(a) of the Bankruptcy Code, which provides in part:

a governmental unit may not deny…a grant to…a person that is or has been a debtor under [the Bankruptcy Code]…solely because such…debtor is or has been a debtor…has been insolvent before the commencement of the case…or during the case but before the debtor is granted or denied a discharge, or has not paid a debt that is dischargeable in the case under this title or that was discharged…

The trustee argued that Section 525 applied because the PPP is by nature a grant rather than a loan because the debt is to be forgiven.

The SBA responded that the Small Business Act precluded the injunctive relief sought by the trustee, which provides that the SBA:

May…sue and be sued in any court…but no attachment, injunction, garnishment, or other similar process…shall be issued against the [SBA].

The SBA relied on a case from the Sixth Circuit Court of Appeals in asserting that the Small Business Act:

…provides basically that parties may proceed against the SBA but only as Congress has provided. [When the SBA brought] an action against a private party, and where that private party brings a counterclaim that implicates the SBA’s rights, the SBA’s rights are unaffected unless it is made a party to that action pursuant to the consent statute.

The SBA argued that the bankruptcy court’s authority to adjudicate Alpha’s Section 525(a) claim did not extend to its PPP claim, which did not arise under the Bankruptcy Code. The SBA said that it did not consent to the entry of a final judgment on the PPP claims.

The bankruptcy court, however, found that the SBA violated the Bankruptcy Code’s anti-discrimination provision when it directed lenders to refuse to accept PPP applications from entities owned by bankruptcy debtors. The court stated:

Perhaps nothing illustrates the arbitrariness and caprice of the bankruptcy exclusion rule better than SBA’s explanation. In order to implement a Congressional program intended to protect American workers from unemployment and loss of health insurance, SBA arbitrarily eliminated all workers employed by debtors in bankruptcy and all workers employed by entities whose owners are debtors in bankruptcy… In attempting to expedite the PPP application process, SBA chose a path that was diametrically opposed to its prior practice and the stated intention of Congress to provide funds for payroll, mortgage interest, rent, and utilities to struggling businesses. As the Administrator herself explained “no creditworthiness assessment is required for PPP Loans,” yet the explanation offered by SBA in its Opposition to Alpha’s Motion and Complaint is that it excluded bankruptcy debtors in order “reasonably to assure repayment.”…“Given the obvious purpose of the PPP, it was arbitrary and capricious for Defendant to engraft a creditworthiness test where none belonged.”

The court joined two other courts that considered similar claims in finding that the PPP “loan” is in the nature of a “license, permit, charter, franchise, or similar grant” without which a debtor’s fresh start would be impeded.

As there is no question that the only reason that Alpha’s application was turned away by Community Bank was the ruling by SBA that entities owned by debtors in bankruptcy are ineligible for the PPP program, the court finds and concludes that the SBA’s bankruptcy exclusion violates section 525(a) of the Bankruptcy Code.

The court ruled that the SBA violated the Administrative Procedures Act, 5 USC § 706(C), when it exceeded its rulemaking authority by excluding entities owned by bankruptcy debtors from the PPP program; 706(B), when it arbitrarily and capriciously excluded entities owned by bankruptcy debtors from the PPP program; and Section 525(a), when it directed lenders to refuse to accept PPP applications from entities owned by bankruptcy debtors.

Various courts that have considered these issues have determined that the PPP is not a loan program:

It is a grant or support program. The target grant recipients are small businesses in financial distress. The PPP could only be offered by the government; private lenders do not give away money. PPP funds “are unobtainable from the private sector.” … They also are essential to Plaintiff’s fresh start. … Of all the benefits a government can grant, free money might be the best of all. Denying Plaintiff access to PPP funds solely because it is a debtor violates § 525(a).

Free money? 

Alpha Visions Learning Academy, Inc., v. Jovita Carranza, in her Capacity as Administrator for the United States Small Business Administration, Defendant (Bankr. WDTN) 2020 WL 2893413


I have a distaste for lender against lender litigation.  That goes for any financial institution for that matter.  Perhaps it comes from the doctrine of not airing one’s dirty laundry.  I am reminded of this from a decision that came down this Monday (March 2, 2020, for those reading this in reprint) by the US District Court for the S.D. Indiana.  No one gains from these types of lawsuits. 

If the following story bores you (and it should not) please do read the penultimate statement at the end.

BMO Harris Bank was financing a construction project for its customer, North & Maple LLC, with Midwest Form Constructors, LLC as the general contractor.  Throughout most of the project BMO Harris funded advances to Midwest’s account at Salin Bank and Trust Company to be used for the completion of the construction project.  At some point North & Maple notified BMO Harris to no longer send loan advances to Midwest but instead, to send them to Atlas Funds Control, LLC, the agent for Midwest’s bonding company.

However, when BMO Harris received instructions to transfer funds to Atlas, BMO mistakenly wired the funds to Midwest’s account at Salin.  Salin accepted the wire transfer and credited the funds to Midwest’s bank account and then withdrew most of it as a setoff to credit an outstanding loan made by Salin to Midwest. 

BMO promptly issued a recall request advising Salin of the mistake and demanding that the wire be returned.  Salin did not and instead, completed the setoff transaction.  Salin did this even though it had full knowledge that Midwest was having financial problems.  BMO claimed that Salin knew, or should have known, that the transfer was mistakenly sent to Salin.

BMO Harris brought an action against Salin for unjust enrichment, conversion and replevin.  Salin moved for judgment dismissing the action relying on Article 4A of the Indiana Uniform Commercial Code (yes, the UCC has more than Article 9), arguing that was the exclusive source of rights for financial institutions participating in the federal wire transfer system.  The court began with an examination of the Article 4A definition of a fund transfer:

 [T]he series of transactions, beginning with the originator’s [North & Maple] payment order, made for the purpose of making payment to the beneficiary [Midwest] of the order. The term includes any payment order issued by the originator’s bank [BMO Harris] … intended to carry out the originator’s payment order. A funds transfer is completed by acceptance by the beneficiary’s bank [Salin] of a payment order for the benefit of the beneficiary of the originator’s [North & Maple] payment order.

Keep in mind that North & Maple’s payment order was for the funds to go to Atlas – not Midwest.  The Court went on to consider Section 211 of Article 4, which provides:

(a) A communication of the sender [also North & Maple] of a payment order canceling or amending the order may be transmitted to the receiving bank [Salin] orally, electronically, or in writing[.]

(b) Subject to subsection (a), a communication by the sender [North & Maple or BMO standing in its shoes] canceling or amending a payment order is effective to cancel or amend the order if notice of the communication is received at a time and in a manner affording the receiving bank a reasonable opportunity to act on the communication before the bank accepts the payment order.

(c) After a payment order has been accepted, cancellation or amendment of the order is not effective unless the receiving bank [Salin] agrees or a funds-transfer system rule allows cancellation or amendment without agreement of the bank.

The Court then turned to case law from other districts, focusing on a New York case:

“[P]arties whose conflict arises out of a funds transfer should look first and foremost to Article 4A for guidance in bringing and resolving their claims[.]” …. If a situation is unequivocally covered by particular provisions in Article 4A, then it is beyond debate that Article 4A governs exclusively. …. However, courts should not interpret this directive to mean that Article 4A has “completely eclipsed” the applicability of common law in the area of funds transfers. …. (Article 4A “does not establish a legislative intent to preclude any and all funds transfer actions not based on Article 4A”); ….(holding that Article 4A did not preempt common law claim when the UCC was “silent” as to the factual scenario alleged);. Rather, preemption likely does not foreclose common law claims related to funds transfers when the disputed “conduct or factual scenario is not addressed squarely by the provisions of [Article 4A].”

The Court went on to conclude:

Article 4A does not squarely address BMO’s allegations and thus does not preempt the common law claims presented.

However, that did not end the case: it only denied the motion to dismiss.  BMO Harris still needs to prove its case – especially that Salin knew of Midwest’s financial distress and that BMO would no longer be sending wires to Midwest. 

Perhaps reasonable minds will prevail and the banks will recognize their risks and reach a settlement.

BMO erred and Salin took advantage of it.  There was a time when financial institutions would not seize upon an opportunity like this.  Disputes such as these reflect poorly on the industry and only help to fuel borrowers’ claims against lenders.

Here comes the penultimate statement.

How could they have avoided airing their dirty laundry?  Arbitration. With arbitration the same result could have come about but without the notoriety of having the decision made public.  Yes, one of the major benefits of arbitrating disputes is that the process may remain confidential.  Had these parties submitted their dispute to arbitration those of you thinking “How dumb” or “How greedy” would never have known of this. 

You will be reading more on these pages about using arbitration in commercial finance disputes.  Its time has come.

BMO Harris Bank N.A. v Salin Bank and Trust Company, 2020 WL 998657, (SD Indiana, March 2, 2020)


There is always room for another PACA story.  Perhaps had Produce Pay, Inc. read this blog it would be in a better position today.  Instead…., well read on.

Produce Pay billed itself as a  “multi-service finance company” that could provide “access to cash flow…the day after you ship your produce to the U.S.”.  Spiech Farms, LLC is a grower and processor of blueberries, asparagus, and grapes.  Spiech fell on hard times in early 2017 when frost destroyed a significant portion of its blueberry crop. In an attempt to shore up its financial state, Spiech entered into a “Distribution Agreement” with Produce Pay.

The Distribution Agreement provided that Spiech would notify PP that it had a pallet of produce for sale by registering that pallet on Produce Pay’s software platform. Produce Pay would then purchase the pallet of produce from Spiech for half the market price. In connection with that purchase, Spiech would assign “all right, title and interest” in the produce to PP, but Spiech would keep the produce in its possession.

 Spiech would then sell, or attempt to sell, that produce to a grocery store or other customer. Whether Spiech sold the produce or not, it was obligated to repay the money it received from Produce Pay, plus a commission, within 30 days after receipt. After 30 days, the commission rate increased. After 60 days, Spiech had to “repurchase” the produce from Produce Pay by repaying the purchase price to Produce Pay, plus a commission.  Although the agreement claimed the transaction to be a purchase of the produce, In effect, the agreement, provided for short-term loans from Produce Pay as a partial advance on payments that Spiech expected to receive from its existing customers. Also by listing its produce on Produce Pay’s software platform, Spiech could potentially reach new customers. If Spiech sold the produce to a customer introduced by Produce Pay, then Produce Pay would receive a higher commission.

As you must have anticipated, Spiech filed for bankruptcy protection.

Produce Pay asserted a $1 million PACA claim against the bankruptcy estate to recover the unpaid cash advances that Produce Pay made to Spiech. The bankruptcy court held an evidentiary hearing and denied Produce Pay’s claim.  Produce Pay appealed to the United States District Court for the Western District of Michigan.

Readers of WCS will recall our two-part blog published in March of 2018, which addressed a decision of the Ninth Circuit Court of Appeals in which the Ninth Circuit reversed its long standing policy of not exercising a “true sale” analysis in situations concerning factoring of PACA receivables.  In doing so the Ninth Circuit joined the Second, Fourth and Fifth
Circuits, holding:

…. a PACA trustee’s true sale of accounts receivable for a commercially reasonable discount from the accounts’ face value is not a dissipation of trust assets and, therefore, is not a breach of the PACA trustee’s duties. … (“The assets of the trust would thus have been converted into cash and the receivables would no longer have been trust assets.”… “[A] ‘bonafide purchaser’ of trust assets receives the assets free of claims by trust beneficiaries” and noting that the determinative issue on appeal is whether the “factoring agreement” was a loan secured by accounts receivable or a true sale of accounts receivable); … (“[N]othing in PACA or the regulations prohibits PACA trustees from attempting to turn receivables into cash by factoring. To the contrary a commercially reasonable sale of accounts for fair value is entirely consistent with the trustee’s primary duty.”)…

Produce Pay apparently believed that by purchasing produce with full recourse it would obtain the benefits of a PACA trustee.  Instead, it paid a high tuition for its lesson.

The District Court affirmed the bankruptcy court’s denial of  Produce Pay’s PACA claim, stating:

The bankruptcy court properly determined that Spiech did not transfer its receivables, or any other interest protected by a PACA trust, to [Produce Pay]..

The District Court went on to say:

…when making this determination, the bankruptcy court employed a “transfer-of-risk” test that has been used in circumstances that are different from the instant case. In the cases cited by the bankruptcy court, courts applied this test to determine whether the buyer of agricultural commodities breached its duties as a PACA trustee when entering into what was either a lending arrangement or a sale of the buyer’s rights in its own receivables. [citations omitted] But there is no reason why the same test should not apply to the agreement between Spiech and [Produce Pay]. Indeed, the UCC recognizes that it is not unusual for a commercial agreement to “blur” the distinction between a transaction “in which a receivable secures and an obligation” and one in which “the receivable has been sold outright.” [citation omitted] This is one of those agreements. Although the circumstances of the aforementioned cases were different, the transfer-of-risk test performs the same basic function in those cases as it does in this one; it helps the court distinguish the true nature of the parties’ agreement. It was not improper for the bankruptcy court to employ a widely-used test to ascertain whether the distribution agreement assigned Spiech’s rights in its receivables.

Although not specifically stating it, both courts utilized a “true sale” test.  Simply, Spiech sold its produce or its receivables, Produce Pay retained full recourse to Spiech, denying it the protection of a “true sale.”

Had Produce Pay followed this blog [OK, the facts in this case preceded the March, 2018 blog] it would have been $1mm richer.

The takeaway for lenders and factors following this blog is to exercise caution when dealing with collateral that is protected by PACA. When PACA bites, it takes  a pound of flesh with it.

In re: Spieth Farms, LLC, Debtor, Produce Pay, Inc v Spiech Farms, LLC. (United States District Court, W.D. Michigan, December 17, 2019)


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.