Question/Answer for Assignments 16, 17 and 18 (Perfection, the Article 9 Filing System, and the Financing Statement)

Some very good questions on this block of material.

1. Section 9-517 says that the filing officer screwing up and not indexing a filing correctly "does not defeat the effectiveness of the filed record." As I understood what you said in class, that means that if the secured party presents a UCC-1 for filing and it is accepted, but the filing officer then goofs up and throws it in the trash instead of indexing it, or indexes it under the wrong name, the secured party's security interest is still perfected.

But suppose six months later, I buy the collateral from the debtor. Before I bought it, I went to the records (like I'm supposed to do) and didn't find a financing statement on file (because of the filing officer's screw-up). So based on the fact that I didn't find anything on file, I went ahead with the deal. Shouldn't I take free of the security interest?

This looked like the example you mentioned in class, where the secured party tried to file, and the filing officer wrongly refused the filing — in which case, Section 9-516(d) says the secured party is perfected — but then someone else bought the collateral in reliance upon having searched the record and having found nothing. In that case, you said that under Section 9-516(d), the buyer would take free of the security interest, having relied on the record. So shouldn't the same result follow if the filing officer accepted the record but lost it or misindexed it, and a buyer relies to his or her detriment on not finding any filing?

The cases do look similar, so it's a fair comparison. But, the UCC treats them differently. In your hypothetical, where the filing officer accepted the filing but then lost it or misindexed it, the secured party is perfected. And none of the buyer-protective rules in Article 9 (such as Section 9-516(d)) apply in this situation. Thus, under the default rule in Section 9-315(a)(1) (the derivative title rule), the buyer will take the collateral subject to the existing perfected security interest, even though the buyer had no practical way to discover the perfected interest because of the misindexing problem.

You can argue that this was a bad policy choice by the drafters. They justified that result because (a) it is consistent with pre-UCC authority and the weight of authority dealing with the same issue in real estate recording cases, and (b) they thought that the secured party shouldn't bear the consequences of the filing office's mistake. But, as your question correctly points out, the filing officer is also responsible in the "wrongly refused filing" case, and yet Section 9-516(d) protects the good faith buyer in that situation.

The argument for the contrary result is, to me, more persuasive. As between the filer and the searcher, the filer here is the cheaper cost avoider. The filer knows that he or she filed, and is thus in a position to "check back" with the filing office and double-check the records to make sure that the filing was indexed correctly and can thus be found by searchers. By contrast, the searcher doesn't know that the filing was ever made. It seems to make more sense to put the burden on the filer to make sure the filing is done right. But that's not what the drafters did.

So given this risk, how can you ever really be "sure" that you'd be getting clear title, or that you would have first priority?

You can't, if by "sure" you mean 100%. It's a risk that a filing officer might lose or misindex a filing after accepting it, but it's a very small risk. In most cases, it's a risk that lenders accept, because it's very unlikely to occur frequently.

As I mentioned in class in response to Billy's question, there are "funds" in some states that are like an insurance fund, with a small amount from each filing fee going into a fund that can be available in case the state waives the filing officer's immunity and someone proves they were damaged because of the filing officer's negligence in misindexing or losing a filing.

The other potential source of "comfort" is Article 9 lien insurance, which the authors mention briefly on page 324. Sometimes, a lender on a big (i.e., multi-million dollar) line of credit might ask a title insurance company to insure the priority of the lender's lien. If the title insurer issues that insurance, the title insurer ends up taking on the risk of a misindexed filing that means the lender really doesn't have first priority due to the misindexing, and if that risks comes to pass, the title insurer is on the hook for the loss. As the book suggests, a lender could get that lien priority insurance. A buyer of collateral, however, cannot.

2. Suppose that my classmate and I formed a general partnership to practice law together. Because we didn't take BusOrgs, we didn't actually make a written partnership agreement, and we didn't file any paperwork with the Secretary of State. We borrowed $50,000 from our parents to buy office furniture and equipment and to cover our start-up costs, and we agreed to give our parents a security interest in all of our equipment and accounts. Would our parents have to have both of us sign a security agreement? What if only one of us signed? And what name would the parents have to use for the "debtor" on the financing statement if there's no written partnership agreement?

General partnerships are not "registered organizations" under the UCC, precisely because they can exist without a written agreement. A limited partnership, LLC, or corporation cannot — it can't exist unless the proper documents are executed and filed with the Secretary of State. But two people can start a general partnership with not much more than a handshake.

If there is a written partnership agreement, it will typically provide the name of the partnership, and that's the name that should be used on the financing statement. Section 9-503(a)(6)(A). [So, as part of their "due diligence," the parents would want to find out if there is a written partnership agreement, and if so, to review it to learn the name (and ask the partners to certify that it is the true partnership agreement and hasn't been amended or changed, and that they haven't held themselves out or represented themselves under other names).]

If there is no written partnership agreement, then the parents should list the legal names of all the partners on the financing statement. Section 9-503(a)(6)(B).

The security agreement question is different. Under the law governing general partnerships, any partner can act as an agent for the partnership. So if your classmate signs on behalf of the partnership, that would bind the partnership — and since all general partners are liable for the debts of the partnership, your classmate's signature on behalf of the partnership would bind you too. The parents could (and probably would) have you both sign, to be safe — that would be especially prudent of them if the two of you don't have a written partnership agreement, because in that case it might be more problematic to prove there was actually a partnership, and if they get you both to sign, it moots that concern.

3. In Problem 18.3, you suggested that Smith might be better off to levy on the Trimble Ave. store assets before it contacts Glacier Bank (because contacting Glacier Bank might tip it off that it failed to perfect its security interest and that might cause them to fix the problem before you can complete the levy). I get that, but isn't it also possible that if I levy on the Trimble Ave. store assets, the debtor will respond by filing for bankruptcy — in which case, the bankruptcy trustee can undo my lien and I have to give the stuff right back? Don't I have to take that account, as the judgment creditor, in doing the cost-benefit analysis to decide whether to have the sheriff complete the levy?

Absolutely, you have to take that into account. [We haven't talked about the bankruptcy trustee's preference avoiding powers yet — that's Assignment 31 — but you are correct that if the debtor files bankruptcy after the levy but before the sheriff can conduct a sale, it is almost certain that the trustee will be able to set aside the creditor's judgment lien as a preference. And in that case, the creditor would have to return the property to the trustee.]

But taking that into account doesn't mean you would necessarily decide to tell Smith not to try to levy. In the cost-benefit analysis, Smith is trading off the potential benefit of levying and getting a lien (and thus the possibility of recovering his judgment out of those assets) against the risk of incurring additional costs, but still not recovering, if it turns out that Glacier Bank really did have a perfected security interest (perhaps it filed but the filing was misindexed) or if it turns out that the debtor responds by filing bankruptcy. If it is going to cost Smith a few hundred bucks to send the sheriff out to levy, Smith may decide to go ahead and take that risk. If the debtor files bankruptcy, Smith ends up no worse off than he would've been anyway (other than being out the few hundred bucks), but that may be a good gamble if there is no UCC-1 filing on the record (because Glacier Bank probably really is unperfected as to the assets), and the debtor may not actually file for bankruptcy.

So you definitely have to consider that risk, but the mere presence of that risk wouldn't (or shouldn't) necessarily discourage you from going ahead with the levy if that levy otherwise is prudent.

4. Can you discuss the problems in Problem 18.2 that you skipped in class?

In Problem 18.2(b), the financing statement describes the collateral as "the proceeds of any lawsuit due or pending." The intended collateral is the debtor's right to be paid under a patent infringement suit, which would be a "commercial tort claim" under UCC § 9-102(a)(13).

Assuming that the security agreement actually created a valid security interest in the lawsuit, then the financing statement is probably good enough to perfect that security interest, but that answer is somewhat less than 100% clear.

UCC § 9-108(e)(1) could come into play with regard to the security agreement. That section says that "a description only by type of collateral ... is an insufficient description of ... a commercial tort claim." If the security agreement described the collateral as "the proceeds of any lawsuit due or pending," that kind of generic description may not be sufficient for attachment purposes under § 9-108(e)(1) (technically, the description uses "lawsuit" rather than a UCC-defined term, but it is generic, and the idea behind § 9-108(e)(1) is the security agreement should use a specific description in such a transaction).

But if the security agreement was sufficiently specific — for example, if it described the collateral as "debtor's rights in the lawsuit captioned Davis Labs, Inc. v. Smithton Industries, LLC" — § 9-108(e)(1) would be satisfied. Then the question would be whether the financing statement is sufficient to perfect that interest. The comments to Section 9-108 make clear that its provisions are focusing on the sufficiency of a description for attachment purposes, in the security agreement, and that it is Section 9-504 that is pertinent with respect to the sufficiency of a description in a financing statement.

Under Section 9-504, a description is sufficient if it 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. Certainly, the financing statement in this problem doesn't cover all assets or all personal property. So it will only be sufficient if it includes "a description of the collateral pursuant to Section 9-108." Here, I suppose, people could quibble. Some might argue that the description wouldn't satisfy Section 9-108 because it would violate Section 9-108(e). But here, the financing statement does not describe the collateral by using the UCC term "commercial tort claims," so it isn't describing the collateral by "UCC type," but by "category" ("any lawsuit due or pending"), and that is sufficient under Section 9-108(b)(2). So I think the better argument is that it would probably be good enough to perfect. But I wouldn't give a client an unqualified legal opinion to that effect.

In Problem 18.2(d) the problem is that the Secured Party is completely wrong — it named "Elizabeth Warren" as the Secured Party when it should have been "Lynn Lopucki." [This is unlike example (c) in class, where the Secured Party was identified by its trade name. In that case, I suggested, the Secured Party's name is not really even in error (the UCC doesn't say a trade name for the secured party is ineffective) or, if it is an error, it certainly isn't seriously misleading, since filings are indexed in the name of the debtor and not the secured party.]

By contrast, in 18.2(d), the name is clearly incorrect. It's clearly an error. Is it a "seriously misleading" error? On the one hand, the drafters appear to argue that it is not. Comment 2 to Section 9-506 takes the view that "Inasmuch as searches are not conducted under the secured party's naem, and no filing is needed to continue the perfected status of [a] security interest after it is assigned, an error in the name of the secured party or its representative will not be seriously misleading." The drafters appear to be saying that a third party would find this statement, inquire of Elizabeth Warren, who would presumably say "No, the debtor doesn't owe me anything; I don't have a security interest in the debtor's collateral." The third party should then inquire further of the debtor and say "What's up with this filed UCC-1? Elizabeth Warren says it's a mistake. Did you authorize someone else to file?" and that at that point, the Debtor will say "Oh, that should be Lynn Lopucki instead," and the third party can then inquire of Lopucki and get the information it needs. That may be an unwarranted amount of confidence that searchers can really get that information in a reasonable inquiry. I would expect that some bankruptcy courts would ignore the comment and would say this is a seriously misleading error; others would probably accept the comment and say the UCC-1 was effective and the secured party's interest was properly perfected.

5. I have a question about Problem 18.6. The debtor applies to Second Bank for a loan. Second Bank asks the debtor for permission to file a financing statement, the debtor says "OK" and Second Bank files a UCC-1 covering the intended collateral. At that point, based on what you said today, Second Bank's filing is not authorized, because the debtor didn't grant authority in an authenticated record and at that point, the debtor hadn't yet signed a security agreement so there couldn't have been implicit authority. Have I got that right?

Yes, you do. At that point, Second Bank has filed a UCC-1 without the authority to do so, and at that point, the filing is not effective (even though it is "filed").

Then later, Second Bank's search comes back clean, and it closes the loan, and it has the debtor sign a security agreement. At that point, does the prior UCC-1 filing become retroactively authorized and thus effective?

Yes. If you look at comment 3 to Section 9-509, you'll see that "Law other than this Article, including the law with respect to ratification of past acts, generally determines whether a person has the requisite authority to file a record under this section." This suggests that once the debtor signs the security agreement, that action likely ratifies the secured party's having filed the earlier financing statement (as long as the collateral description in that filing isn't broader than the collateral description in the security agreement). So at that point, the secured party's filing, even if it wasn't effective before, becomes effective at that point, and Second Bank's security interest is perfected.

So in that Problem, Second Bank would get priority over the security interest taken by NationsBank and perfected on March 10?

Probably, yes. Under Section 9-322(b)(1), priority between two perfected security interests in the same collateral is resolved by "first to file or perfect." NationsBank was first to perfect, on March 10. But Second Bank was first to file, on March 1. [That's the date it "filed."] NationsBank might try to argue that Second Bank's "filed" date should be considered to be March 15, when its filing was retroactively authorized when the debtor signed the security agreement. And section 9-510(a) does provide a statutory leg for NationsBank to stand on, by saying that "A filed record is effective only to the extent that it was filed a person that may file it under Section 9-509." But the priority provision still allocates priority based on "first to file or perfect" and Second Bank's UCC-1 was still stamped "filed" on March 1, and by the time of the dispute, it is effective. So I think NationsBank will lose in priority.