What is a purchase money security interest (PMSI)?
Section 9-103 of the UCC defines a PMSI as a security interest in goods that are collateral for an obligation that arises in connection with the sale of the goods. When the required steps are met a PMSI can give a creditor a first or priority security interest in the goods even if other secured parties hold prior perfected security interests in the same collateral.
How does the creditor stay compliant with PMSI requirements?
Article 9-324 (b) outlines the requirements for a secured party to obtain a PMSI in inventory:
- the purchase-money security interest is perfected when the debtor receives possession of the inventory;
- the purchase-money secured party sends an authenticated notification to the holder of the conflicting security interest;
- the holder of the conflicting security interest receives the notification within five years before the debtor receives possession of the inventory; and
- the notification states that the person sending the notification has or expects to acquire a purchase-money security interest in inventory of the debtor and describes the inventory.
An example of how a secured party can lose priority…
Secured parties must strictly comply with the Article 9 PMSI requirements. This process is an exception to the “first to file” priority rule. Let’s use the case of T. Gluck & Co., Inc. v. Craig Drake Mfg., Inc., 2013 N.Y. Misc. LEXIS 2384 (N.Y. Sup. Ct. June 4, 2013) to demonstrate how a secured party can lose priority if it does not comply with the requirements.
Craig Drake Mfg., Inc. (the “Debtor”), a jewelry manufacturer, entered into a revolving credit agreement in 1989 with a lender that later sold the loan and security interest to Sovereign Bank (collectively, the “Bank”).
The revolving credit agreement granted the Bank a security interest in the current and future accounts and inventory.
On July 27, 1989, the Bank perfected its security interest in the Debtor’s assets by filing a financing statement. The bank protected its security interest in 1994, 1999, 2004 and 2009 by filing continuation statements.
T. Gluck & Co. (“Gluck”) contracted to supply diamonds to the Debtor on consignment in 1997. Gluck sent a notice to the Bank later in 1997 to protect its interest in the consigned goods and filed a financing statement soon after.
12 years later in 2009, the Debtor retained a firm to manage a going-out-of-business sale. The sale lasted several months with most of the proceeds going to the bank. Gluck was not paid for a portion of the goods consigned to the Debtor.
Gluck then brought a lawsuit against the Bank at the end of 2009, alleging that it held the priority interest in the consigned goods. The bank disputed Gluck’s allegations. The court determined that under the UCC, Gluck’s interest in the consigned goods was a PMSI in inventory. Gluck had to prove it complied with the PMSI requirements to have the priority interest in the goods.
Gluck originally sent The Bank a PMSI notice in 1997. Unfortunately for Gluck, they never sent another notice of its claimed security interest in the consigned goods.
The court concluded that the PMSI notice expired in 2002 and was never re-sent and Gluck was not entitled to PMSI priority. The general rule of “first to file”, “first in line” would be applied. The Bank had first priority because it was the first to file in 1989.
Lesson Learned: do not fail to re-send a PMSI notice.
Steps to comply with Article 9 PMSI requirements
It is very important, as we learned in the case above, that a secured party that claims a PMSI in inventory must re-send the authenticated notification every five years. The general priority rules state that failure to resend a notice renders the secured party’s security interest subordinate to prior perfected security interests. The best practice is for the secured party to resend its PMSI notices prior to the time it continues the financing statement every 5 years to avoid the result found in the case of T. Gluck & Co., Inc. v. Craig Drake Mfg., Inc.
Have you successfully perfected your Purchase Money Security Interest?