Unperfected Liens Can Leave Creditor’s Claim Unsecured

January 19, 2012Articles Daily Business Review

Do you feel secure that your claim will be secured in a bankruptcy?

In many cases over the years, creditors thought their security interests were fully perfected, only to find they failed to take the necessary steps before the borrower filed for bankruptcy.

For a lender, timely and proper perfection is imperative. Otherwise, you may end up sharing with unsecured creditors the proceeds of what you thought was your collateral.

Perfecting a lien or security interest puts the world on notice that a creditor is claiming rights against a borrower's property. Generally, a perfected lien is superior to any liens that follow.

Pre-bankruptcy perfection is vital because of the trustee's strong-arm powers under Section 544(a)(1) of Title 11. In bankruptcy a trustee or debtor-in-possession can avoid an unperfected lien, leaving the creditor's claim unsecured.

Section 544(a)(1) provides that, after the bankruptcy filing, a trustee can avoid any transfer made or obligation incurred by the debtor that would be voidable by a judgment lien creditor under nonbankruptcy law. So it is always in the secured party's interest to perfect as soon as possible.

For example, assume a Florida corporation takes out a $1 million loan. To secure the loan, the borrower signs a promissory note in favor of the lender and a security agreement granting a security interest in its inventory. However, the lender fails to file a UCC financing statement with the secretary of state's office to perfect its security interest in the inventory.

Four months later, the borrower files for Chapter 7 bankruptcy. The trustee, with all the rights and powers of a judgment lien creditor, takes priority over the lender's unperfected security interest and effectively avoids the lender's security interest in the borrower's inventory.

As a result, the lender is relegated to the position of an unsecured creditor, and the trustee is free to liquidate the inventory and distribute the proceeds to all the creditors. If the lender had just filed a financing statement and perfected its claim, it would be the only creditor that could claim the inventory.

The procedure for perfecting a lien may differ from state to state and depends on the type of property. Common examples of perfected security interests are car titles signed with the lienholder's name and home mortgages recorded in the county where the property is located.

In contrast, as a general rule, personal property liens are perfected by filing a financing statement where the borrower is located. For example, the financing statement for a Florida resident or registered organization, such as a corporation, should be filed with the Florida secretary of state's secured transaction registry.

Filing a financing statement is simple but filling it out requires great attention to detail.

First, be certain the financing statement bears the correct name of the borrower. Even minor mistakes or omissions in the name could invalidate the financing statement. Florida Statute 679.5031; Official Committee of Unsecured Creditors v. Regions Bank (In re Camtech Precision Manufacturing, Inc.), 443 B.R. 190 (Bankr. S.D. Fla. 2011) (bank's financing statements were ineffective); In re John's Bean Farm of Homestead, Inc., 378 B.R. 385 (Bankr. S.D. Fla. 2007) (financing statement seriously misleading where creditor failed to provide debtor's correct legal name, identifying debtor as John Bean Farms, Inc. instead of John's Bean Farm of Homestead, Inc.).

Second, be sure the security agreement grants a security interest in everything covered by your financing statement. Florida Statue § 679.5021, 679.5041, 679.1081. Failure to include in the financing statement all collateral listed in the security agreement could limit your security interest. Listing collateral that is not included also will invalidate it.

Here are other common examples of how to perfect collateral: file a financing statement for security interests in patents and trademarks; register and record with the U.S. Copyright Office security interests in copyrights; and, to perfect security interests in liquor licenses, record a mortgagee's interest in spiritous alcoholic beverage license with the state Department of Business and Professional Regulation under Florida Statute § 561.65, along with a copy of the promissory note and security agreement, within 90 days.

Be perfect and perfect!

Reprinted with permission from the January 19 issue of the Daily Business Review. © 2012 ALM Media Properties, LLC. Further duplication without permission is prohibited. All rights reserved. For information, contact 877-257-3382 or [email protected] or visit www.almreprints.com.