Enforcing the UCC-1

Over the past few years, I have seen an increasing number of problems encountered by clients in their attempts to collect debts, particularly against secured collateral.
 
These problems typically arise from the sale of a business in which the seller finances a part of the purchase price and attempts to create a security interest against some of the business’s assets by filing a UCC-1 financing statement with the Secretary of State.  

UCC-1 filings are valuable tools in seller financing situations.    However, they are not fool-proof.   The UCC-1 is used to perfect a security interest in collateralized assets and establishes priority of repayment in case the debtor defaults or declares bankruptcy.  When a UCC-1 is used, it is very important that the assets used as collateral be clearly and specifically identified. 

While courts are generally liberal in construing a UCC-1 to create a security interest, and will generally overlook technical errors, it is imprudent to blindly rely on luck and the good graces of the judicial system.

Let’s look at a hypothetical situation to see how this works.  Sam Sellit decides to sell his restaurant, Sam’s Super Subs, to Betty Byett (who will use the assets to open Betty’s Better Burgers, of course).    Betty doesn’t have enough cash for the full purchase price, and her credit isn’t great.   So, Sam agrees to finance $50,000 of the purchase price.   Sam is smart, so he takes a security interest in the restaurant equipment and files a UCC-1 financing statement with the Secretary of State. 

Several years later, Betty – whose burgers weren’t better – defaults on her payments.   Sam seeks to recover the equipment under his security agreement.   Unfortunately, when Betty realized her business was finished, she sold all of the equipment at an auction and spent the proceeds. 

Sam’s UCC-1 filing states that he has a security interest in “all of the equipment on the premises.”  Because the items were not specifically identified, Sam will not be able to recover the items from any third-party purchasers who were unaware that these specific items were covered by Betty’s security agreement. 

How should Sam have written his UCC-1 to avoid this problem?   If Sam had used specific descriptions of each asset of significant value, including each asset’s serial or other identifying number, it would have been clear which ice machine, grills, and fryers were covered by his UCC-1.   Accordingly, Sam would be able to enforce his UCC-1 against third-party purchasers with relatively little difficulty.  

While this level of specificity is not required by law, it is good business practice.   It requires a little more effort on the front-side, but can save a lot of headache – and money – down the road.

Caveat Venditor.