A security interest may be perfected by taking possession of the property that constitutes the collateral; however, this type of security interest is only intended to be short-term.
A case involving Schwinn Cycling and Fitness, Inc.*, is a great example of why you should file a UCC even if your security interest is temporarily secured by possession.
Expeditors International of Washington, Inc. (“Expeditors”), the creditor in this case, shipped goods for Schwinn Cycling and Fitness, Inc. (“Schwinn”), the debtor. The agreement between the parties indicated that Expeditors had a security interest in all of Schwinn’s property in creditor’s possession, custody and control.
A Few Important Facts
- Within 20 days prior to Schwinn’s bankruptcy filing, Expeditors had some of Schwinn’s property in its possession & the property was then provided to Schwinn during this same 20 day window.
- Expeditors did not file a UCC Financing Statement within the 20 days of transferring the collateral to Schwinn.
Expeditors contended it had a security interest perfected by possession prior to Schwinn’s bankruptcy petition, so the security interest remained perfected during the pendency of the bankruptcy. The bankruptcy trustee contended the security interest became unperfected because Expeditors did not file a UCC Financing Statement, making the security interest avoidable in bankruptcy.
The court agreed that under the version of the Uniform Commercial Code in Colorado, where the case arose, Expeditors continued to have a temporarily perfected security interest in the collateral, for twenty days after transferring the collateral back to Schwinn. However, the court also agreed that after the twenty day window the security interest became unperfected because no financing statement was filed.
Expeditors argued the temporary perfection of its security interest extended indefinitely, because Schwinn filed for bankruptcy during the twenty day window, so the automatic stay froze priority upon initiation of insolvency proceedings. However, the court indicated that this type of short-term perfection was not intended to continue throughout the duration of a bankruptcy proceeding, which could last for years.
The court distinguished prior cases that involved a bankruptcy filing during the twenty day window. In those cases a UCC had been filed, therefore subsequent creditors could not claim to have been misled by “secret security interest”.
The Best Practice
Generally, a UCC Financing Statement that meets the statutory requirements should always be filed. The most effective way to protect a security interest is to have UCC professionals prepare a financing statement and comply with other perfection procedures.
* Expeditors International of Washington, Inc., Plaintiff/Appellant, v. The Liquidating Trust, as transferee of interests of the Estate of Schwinn Cycling and Fitness, Inc., Defendant/Appellee. (United States Bankruptcy Court, D. Colorado. August 6, 2004.)