Collateral Description in UCC Filings: a Case from TennesseeNCS Credit - June 17, 2014
A recent case decided by the Sixth Circuit Court of Appeals, 1st Source Bank v. Wilson Bank and Trust et al., 2013 WL 5942056 (No. 13-5088), provides an example of the importance of properly describing collateral in a UCC filing to perfect a security interest. In the case, the key issue was whether or not the language describing specific heavy machinery and “all proceeds thereof” was sufficient to include the debtor’s accounts and accounts receivable.
In 2004, 1st Source Bank arranged for the lease or sale of certain equipment to K & K Trucking and J.E.A. Leasing (Debtors), which was subject to a security interest that was described in the UCC filing according to the above language. The terms “accounts” and “accounts receivable” were not included in the description of the collateral. Subsequent to the 1st Source Bank UCC filing, the Debtors entered into financing contracts with a number of other banks. These other banks, in turn, filed UCCs which specifically included “all accounts receivable now outstanding or hereafter arising” as part of the collateral description. When the debtor defaulted on the financing arrangements, these banks took control of the collateral, including the accounts receivable. 1st Source Bank objected based on its claimed priority security interest.
The issue before the court was whether the language referring to “all proceeds thereof” was sufficient to put future creditors on notice that 1st Source Bank held a security interest in “accounts” and/or “accounts receivable.” Generally, the legal standard for description of collateral in a UCC filing is that it “reasonably identify what is described.” Courts have interpreted this as meaning that it must be sufficient to create a reason to inquire further about the existence of a security interest in the collateral.
The court addressed the argument that “all proceeds thereof” in the UCC was sufficient to encompass “accounts” and “accounts receivable.” The court noted that Chapter 9 of the Tennessee Uniform Commercial Code (UCC) defines “accounts” separately. The court determined that the term “proceeds” must refer to something different or the use of the term “accounts” would become superfluous. The court also relied on the commentary to Article 9 that indicated the term “proceeds” was not to be construed particularly broadly, so it did not make sense to have it include all monies generated by the equipment. Consequently, 1st Source Bank’s security interest was not perfected with respect to accounts and accounts receivable, providing the other banks a priority status even though their filings were recorded after 1st Source Bank.
Because the collateral that underlies a security interest is the key protection afforded to creditors in the case of debtor default or bankruptcy, collateral must be properly described in UCC filings. The description must be sufficient, to provide notice to prospective creditors of the property encumbered by a prior security interest. On the other hand, the description should not be so specific and narrow that key forms of collateral are not encompassed within the description in the UCC Financing Statement. A creditor with a senior security interest can forfeit a priority position when the UCC collateral description is defective.