Are You Secure? Perfection and Its Consequences Under Revised Article Nine

On July 1, 2001 Oregon enacted into law Revised Article Nine of the Uniform Commercial Code. Revised Article Nine, like its predecessor, governs the creation, priority, perfection, and enforcement of security interests in personal property. A properly perfected security interest is often a critical component of a business sale or financing transaction. Unfortunately, there are often unintended consequences from new legislation. Revised Article Nine is no exception.

As a uniform law, every State adopted Revised Article Nine to simplify the rules for creation, priority, perfection, and enforcement of security interests. One way Revised Article Nine attempts to simplify these rules is by centralizing the location where financing statements, sometimes referred to as UCC-1’s, are filed to perfect a security interest. For example, under former Article Nine, you would file a financing statement where the collateral was located. Under Revised Article Nine, you should file in the place of residence or state of incorporation regardless of where the collateral is located. Once filed, the financing statement usually perfects a security interest for a period of five years.

Revised Article Nine contains a complicated set of transition rules. These rules slowly phase into effect the changes included in Revised Article Nine. One of the most important transition rules concerns the effectiveness of a financing statement under old Article Nine. Because of the change in where to file a financing statement, without this rule a financing statement filed in the wrong state under Revised Article Nine would be invalid.

To prevent this, Revised Article Nine states that a properly filed financing statement under former Article Nine remains valid even if filed in the wrong jurisdiction until it expires or until June 30, 2006, whichever is earlier. The same provision of Revised Article Nine permits a properly filed financing statement to be continued under some circumstances. As a result, a financing statement filed under former Article Nine may not expire until after June 30, 2006, applying the traditional five year expiration rule. However, Revised Article Nine makes clear that the financing statement expires on June 30, 2006.

This unintended rule could result in a creditor losing its perfected security interest if it fails to file a financing statement in the correct jurisdiction before June 30th. To further complicate matters, Revised Article Nine also has a number of rules about when a financing statement or continuation statement can be filed. Regardless of these provisions, the best immediate solution to prevent a potential loss of secured status is to immediately confirm that a financing statement is properly filed prior to June 30, 2006. If it is filed in the wrong jurisdiction, a new financing statement should be filed in the proper jurisdiction as soon as possible.

In addition to unintended consequences, a recent court ruling from the Sixth Circuit Court of Appeals also undermines the priority and perfection goals of Revised Article Nine. In the case of In re: Spearing Tool and Manufacturing Co., Inc., the Sixth Circuit upheld the Internal Revenue Service’s argument that they are not bound by the creation, perfection, and priority rules under Revised Article Nine. In re: Spearing Tool and Manufacturing Co., Inc., 412 F.3d 653 (6th Cir. June 21, 2005). Consequently, a prior filed lien by the IRS was upheld even though it was invalid under Revised Article Nine.

As a result of this decision, the IRS may take the position that it is not required to comply with the uniform name and filing location rules contained in Revised Article Nine. For example, the IRS could file a financing statement with the wrong name of the debtor. Under Revised Article Nine, a financing statement that lacks the exact legal name of the debtor could be invalid. The IRS could also elect to file a financing statement where the collateral is located. Under the 6th Circuit decision, this financing statement may be valid. While not binding on Oregon courts, it is a significant decision that the IRS will rely upon in the future to correct errors that would otherwise invalidate a lien filing under Revise Article Nine.

A party taking a security interest should undertake adequate due diligence to confirm that no tax liens exist thereby challenging and potentially defeating a secured creditor’s intended priority. If the situation warrants, an abundance of caution approach may justify searching multiple jurisdictions for potential lien filings using a wide variety of name options for the debtor.

Perfection does not come without complications. Despite a significant effort, Revised Article Nine is not perfect and recent judicial decisions have further complicated matters. Despite these setbacks, Revised Article Nine has clarified the process for creating, perfecting, prioritizing, and enforcing security interests in personal property and future judicial decisions should further clarify the application and impact of Revised Article Nine.

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