Revised Article 9 of the Ucc

REVISED ARTICLE 9 OF THE UCC:

WHAT EVERY REAL ESTATE LAWYER SHOULD KNOW

Gary York LeBoeuf, Lamb, Greene & MacRae, L.L.P. 725 South Figueroa Street Los Angeles, California 90017 (213) 955-7301 [email protected]

AMERICAN COLLEGE OF REAL ESTATE LAWYERS

SPRING 2000

WILLIAMSBURG, VIRGINIA

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REVISED ARTICLE 9 OF THE UCC: WHAT EVERY REAL ESTATE LAWYER SHOULD KNOW

Gary York LeBoeuf, Lamb, Greene & MacRae, L.L.P., Los Angeles

A. Highlights.

Revised Article 9 of the Uniform Commercial Code will become law in many states on July 1, 2001, and is the first comprehensive overhaul of the UCC since 1972. The revisions were sponsored by the American Law Institute and the National Conference of Commissioners on Uniform State Laws. Appendix A contains a list of states which have adopted some version of Revised Article 9, and those which are considering it.

Revised Article 9 expands the types of property and transactions covered by its predecessor as well as clarifies rules for creation, perfection, priority, and enforcement of security interests. Revised Article 9 also recognizes electronic transactions and the ever- expanding modes of electronic commerce. For example, signatures on a writing are no longer required; “authentication” of a “record” will suffice.

This paper summarizes only the more significant changes to Article 9 which should be of interest to real estate lawyers. Revised Article 9 contains special rules for consumer transactions, which we will not discuss. Citations herein to sections are to sections of Revised Article 9 (unless otherwise indicated).

B. Broader Scope of Article 9.

1. Prior law refers to “debtors” and “secured parties.” A new category is added: “obligors.” An obligor is the person who owes the secured obligation; a debtor is the person who has a property interest in the collateral. Under Revised Article 9, a debtor now may include a seller of payment intangibles and promissory notes, a consignee, or a person with a property interest in collateral subject to an agricultural lien. 9-102(a)(28). A “secured party” may be a buyer of payment intangibles or notes, and may be a representative for holders of secured obligations, such as an indenture trustee. Under Revised Article 9, a representative (secured party) also may include any trustee, agent or collateral agent. 9-102(a)(72).

2. Although Revised Article 9 excludes landlord's liens and other nonpossessory liens arising by statute or common law, its scope does include agricultural liens. Generally, these are nonpossessory statutory liens on farm products in favor of a landlord, supplier of services or goods in connection with a debtor's farming operations. 9-102(a)(5), 9-109(d)(2).

3. The definition of “accounts” will now include not only payment obligations arising out of the sale or lease of goods or the provision of services, but also the sale, lease, and

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license of many kinds of tangible and intangible property (such as license fees payable for the use of computer programs), as well as credit card receivables. 9-102(a)(2). This will create more certainty with respect to many transactions. The definition of “goods” clarifies that software embedded in goods in considered to be part of the goods. However, the definition of “software” (not embedded in goods) is a “general intangible” and includes related supporting information. 9- 102(a)(42), (44), and (75).

4. Some payment rights are not “accounts” but “general intangibles” (such as rights to payment evidenced by an instrument, and letters of credit). Revised Article 9 creates a new sub-category of general intangibles called “payment intangibles” (that is, a general intangible where the obligor’s principal obligation is the payment of money) and a new sub-category of instruments called “promissory notes.” 9-102(a)(61) and (65).

Since the sale of a payment intangible is often viewed as a financing transaction, the sale of payment intangibles is covered by Revised Article 9. 9-109(a)(3). As stated in part B(c) above, the term “debtor” includes the seller, and “secured party” includes the buyer. A security interest created upon the sale of a payment intangible is automatically perfected; this allows banks to sell loan participations without having financing statements filed against them. 9- 309(3).

A “promissory note” is now separately defined as a sub-category of instruments. 9- 102(a)(65). The sale of a promissory note is also subject to Article 9, and the buyer of a note has automatic perfection of its security interest. 9-109(a)(3), 9-309(4). The buyer of a promissory note should take possession of the note in order to avoid losing to a subsequent purchaser of the note that does take possession. A purchaser of a promissory note that takes possession will have priority over a secured party that perfects solely through the automatic perfection provisions (unless the later secured party knows that its security interest violates the rights of the purchaser). 9-330(d). But a bank which purchases notes may nevertheless decide to take the slight risk of leaving them in the possession of the seller for servicing purposes, because it knows its rights will not be impaired by the bankruptcy of the seller.

5. Prior to Revised Article 9, security interests in deposit accounts were often subject to common law because they were excluded from Article 9 in some states. Certain types of deposit accounts are now included within the scope of Article 9; the new definition of deposit accounts excludes deposit accounts which are evidenced by “instruments.” 9-102(a)(29). Therefore, an uncertificated certificate of deposit is a deposit account (assuming there is no writing evidencing the bank’s obligation to pay), whereas a nonnegotiable certificate of deposit is a deposit account only if it is not an “instrument” (a question that turns on whether the nonnegotiable certificate of deposit is “of a type that in ordinary course of business is transferred by delivery with any necessary indorsement or assignment”). A deposit account evidenced by an instrument is subject to the rules applicable to instruments generally, and therefore a security interest in such an instrument cannot be perfected by control and the special priority rules applicable to deposit accounts do not apply. See Official Comment 12 to 9-102 and part D(9) below regarding perfection by control.

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6. “Letter-of-credit right” is a new category of collateral. It means a right to payment or performance under a letter of credit, whether the letter of credit is written or electronic, and whether or not the beneficiary has demanded or is at the time entitled to demand payment or performance. 9-102(a)(51). Perfection is allowed by obtaining “control,” rather than possession of the original letter of credit. 9-314(a). Perfection can also be achieved by perfection in the underlying obligation and, therefore, in the letter-of-credit rights as “supporting obligations”---see part C(4) below. The term letter-of-credit right does not include the right of a beneficiary to demand payment or performance under a letter of credit. Therefore, a lender which is relying on a letter of credit issued on behalf of a tenant, for example, should attempt to have the letter of credit issued in its own name as beneficiary, and should obtain possession of it. (Note that automatic perfection through perfection in the underlying obligation does not appear to be relevant where a lender is making a loan to a landlord and the letter of credit is security for a lease.)

7. Other additions to the scope of Article 9 are of less importance to real estate lawyers (such as electronic chattel paper, commercial tort claims and health care insurance receivables).

C. Creation and Attachment of Security Interests.

1. Most rules for creation and attachment of security interests are not changed.

2. Security agreements will now require “authentication” by the debtor, but not a signature. 9-203. (Note the difference for financing statements—no authentication or signature will be required, as discussed in part D(3) below.)

3. Description of collateral by an Article 9 category (such as “goods,” “inventory,” or “equipment”) will be a sufficient description of the collateral in a security agreement. 9- 108(b)(3). But security agreements cannot use a “supergeneric” description (such as “all assets” or “all personal property”). 9-108(c).

4. Revised Article 9 creates a new type of rights called “supporting obligations.” These are rights such as letter of credit rights, underlying collateral, and guaranties. They have always been understood to be included with the debt, but Revised Article 9 makes it explicit. 9- 102(a)(51), 9-102(a)(77). Therefore, the creation of a security interest in a “payment obligation” (see above) automatically attaches to “supporting obligations” relating to the obligation, and the perfection of a security interest in the supported obligation automatically perfects the security interest in the supporting obligation. 9-203(f), 9-308(d) and (e).

5. A security interest automatically attaches to proceeds of the collateral. 9-203(f), 9-315(a)(2).

6. Collateral may secure future advances if the security agreement so provides. 9- 204(c). Official Comment 5 to Section 9-204 rejects case law that required that future advances be of the same type or related to an original advance in order to be secured by the collateral.

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D. New Rules for Perfection and Priority.

1. Financing statements will now be filed in the place of the debtor’s location—that is, the state where the charter documents of an entity are filed if the entity is created by filing with the state (not the location of the chief executive office, and not the state where the collateral is located). 9-301, 9-307. If an entity (such as a partnership) is not created by filing, the “location” is the location of its chief executive office. An individual’s location is the principal residence of the individual. Special rules apply to foreign entities and branches of foreign entities. 9-307. (Tip: Be sure the security agreement contains warranties regarding the debtor’s “location.”) Secured parties will now have less concern regarding movement of collateral to other jurisdictions.

2. Generic descriptions of collateral (such as “all personal property” or “all assets”) will now be permitted in financing statements (not in security agreements), provided that the description reflects the actual understanding of the parties. 9-504(2).

3. A debtor’s signature on a financing statement will no longer be required— provided that the secured party has been authorized by the debtor to file a financing statement. 9-502, 9-509. This will allow the electronic filing of financing statements. The authorization required is automatic if a security agreement has been executed with respect to the type of collateral described in the financing statement. 9-509. (For pre-filing of financing statements, the debtor will have to furnish specific authorization.)

4. Get the name right: Courts will no longer have discretion to determine if an incorrect name on a financing statement is adequate to avoid confusion and to establish priority. Whether an erroneous name on a financing statement is seriously misleading will be determined by whether a computer search “using the filing officer’s standard search logic” would disclose a financing statement. 9-506(c).

5. A financing statement is sufficient if it provides the name of the secured party or a representative of the secured party. Thus it need only name the bank acting as collateral agent, and does not need to disclose that it is acting as agent for other banks. 9-502(a)(2).

6. “Filing” under current law means “presentation” of a financing statement to the filing office with the correct filing fee. Revised Article 9 changes “presentation” to “communication” to allow for electronic filing. 9-516(a), 9-102(a)(18).

7. The first person to perfect its security interest will still have priority over other secured parties. 9-322(a)(1). But Revised Article 9 changes and clarifies certain priority rules, especially those relating to exceptions which are not based on the first to perfect principle.

8. Revised Article 9 expands the types of collateral as to which perfection can be accomplished by the filing of a financing statement, such as instruments. 9-310(a). But sometimes possession, control, or other means are also available and should be considered in order to have the most priority protection. Therefore, while Revised Article 9 will now allow perfection of an interest in instruments by filing a financing statement, a subsequent secured

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party that takes possession of the instrument will have priority unless it knows that its purchase violates the rights of the first secured party. 9-330(d).

9. Where perfection is accomplished by possession (such as with promissory notes or other instruments), possession may actually be with a bailee provided that the bailee “authenticates a record acknowledging that it holds possession of the collateral for the secured party’s benefit.” 9-313(c). Tip: For transactions entered into prior to the effectiveness of Revised Article 9, have the bailee authenticate such a record now.

10. “Control” is a method of perfection which previously applied only to investment property but now applies to a broader range of collateral as to which “possession” is not possible, such as deposit accounts, letter-of-credit rights, and electronic chattel paper. 9-203(b)(3)(D) and 9-314(a). “Control” for deposit accounts is defined in Section 9-104 (e.g., the secured party is the bank with which the deposit account is maintained, or the debtor, secured party, and bank have agreed that the bank will comply with instructions from the secured party regarding disposition of the funds in the account). Tip: For transactions entered into prior to the effectiveness of Revised Article 9, enter into such an agreement now. A secured party has control of a letter-of-credit right if the issuer or any nominated person has consented to an assignment of proceeds of the letter of credit under Section 5-114(c) or otherwise applicable law. 9-107. A security interest perfected by control is superior to an interest perfected under the automatic perfection provisions which apply to supporting obligations. 9-329(1).

11. Purchase-money security interests: A secured party may still obtain a purchase- money security interest, but only in “goods” (or in certain cases, in computer software). 9- 103(a)(1). Revised Article 9 makes it clear that a purchase-money security interest will retain its character as such even if (i) the purchase-money debt has been refinanced, (ii) collateral that is not purchase-money secures the debt, or (iii) the collateral also secures other debt. 9-103(f).

12. Only minor changes are made with respect to fixture filings (such as priority rules relating to “manufactured homes”).

E. Foreclosure Sales.

Revised Article 9 attempts to eliminate ambiguities that have come to light in litigation arising out of enforcement of security interests. Rules relating to notices to debtors, other secured parties, and guarantors have been strengthened. 9-102(a)(59), 9-602, and 9-611(c). “Every aspect of a disposition of collateral, including the method, manner, time, place, and other terms, must be commercially reasonable.” 9-610(b). Revised Article 9 resolves conflicting court cases by providing that the failure to comply with notice or commercial reasonableness requirements will not completely bar any deficiency, but will reduce a secured party’s deficiency to the extent that the failure to comply affected the price obtained at the foreclosure sale. 9-626(a)(3).

Guarantors and other secondary obligors are generally entitled to notifications and other rights afforded to the underlying debtor, provided the secured party is aware of their identity. These parties may not waive these rights until after a default. 9-611(c)(2) and 9-624(a) and (b). These rules make explicit what was largely true under case law.

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Other changes (i) provide rules applicable to foreclosure sales where the purchase price is unusually low (9-615(f)), (ii) give a secured party more flexibility in determining the extent to which non-cash proceeds received at a foreclosure sale (such as a note from the buyer) should be applied to the debt (9-615(c)), (iii) permit a secured party to retain collateral (such as intangible collateral) in satisfaction of a debt even if the secured party was not in possession of the collateral (9-620), and (iv) permit a secured party and a debtor to agree that collateral may be retained in partial satisfaction of a debt (9-620(a) and (c)).

F. Transition Rules.

To ease the burden of complying with the transition provisions, the goal of the Drafting Committee was to have a uniform effective date of July 1, 2001. Many states have already adopted Revised Article 9. See Appendix A.

While the transition rules are complex, there are some general principles:

1. A security interest perfected under prior law remains perfected if the acts of perfection under prior law would also perfect the security interest under Revised Article 9. 9- 703(a).

2. Except for security interests perfected by filing under current Article 9, a security interest perfected under current law remains perfected for only one year if the perfection steps under current law are not sufficient to perfect under Revised Article 9. But the secured party can satisfy the new perfection requirements within one year after the effective date, and then the security interest will remain continuously perfected under Revised Article 9. 9-703(b).

3. The filing of a financing statement prior to the effective date will perfect a security interest after the effective date to the extent that the filing is sufficient to perfect a security interest under Revised Article 9. 9-705. Therefore, it is advisable to immediately begin filing financing statements in the correct state under Revised Article 9, and to describe any collateral that may be perfected by filing under Revised Article 9 (such as instruments).

4. A financing statement effective under current Article 9 remains effective under Revised Article 9 until the earlier of (a) the normal date for lapse of the financing statement (i.e., five years after filing) or (b) five years after the effective date of Revised Article 9. 9-705(c).

5. A continuation statement may not be filed in a state unless a financing statement to which it refers was previously filed in that state. Instead, a new financing statement should be filed in the correct state under Revised Article 9 (remember, the signature of the debtor is not required). The new financing statement must, among other things, describe the prior financing statement and the office where it was filed. 9-706.

6. Because financing statements filed under the old law will remain in effect for a number of years, UCC searches will now be required in states where the proposed debtor may have financing statements filed against it under the old law and under Revised Article 9.

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7. For earlier attached but unperfected security interests, see 9-704.

8. For transition rules regarding priority issues, see 9-709.

9. Because of a change in terminology, there may be issues as to which definition of a term in an earlier security agreement was intended--such as “accounts.” It would be helpful to the secured party, for example, if the security agreement described “accounts as presently or hereafter defined in the UCC.”

G. Bibliography.

The foregoing contains only some highlights of a complex subject. For further information, see the following:

1. The New Article 9 (Corinne Cooper, ed., ABA Section of Business Law, 2nd ed. 2000).

2. Janet C. Norris, Letters of Credit Posted by Dot-com Tenants - How Lenders Can Avoid Becoming a Victim of Tulipmania, 18 California Real Property Journal No. 2 (2000).

3. Steven O. Weise, An Introduction to Revised UCC Article 9, 70 Penn B. Ass’n Q 158 (Oct. 1999).

4. Steven O. Weise, A Comparison of the Current Article 9 and the New Article 9, 32 UCC L.J. 270 (2000).

5. Steven O. Weise, A Comparison of a Security Agreement Under the Current Article 9 and the New Article 9, 32 UCC L.J. 300 (2000).

6. Timothy R. Zinnecker, The Default Provisions of Revised Article 9 (ABA Section of Business Law 1999).

7. Web Site for Uniform Law Commissioners: www.nccusl.org

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APPENDIX A

STATE ADOPTIONS OF REVISED ARTICLE 9:

Alaska Kentucky Rhode Island Arizona Maine South Dakota California Maryland Tennessee Delaware Michigan Texas District of Columbia Minnesota Utah Hawaii Montana Vermont Illinois Nebraska Virginia Indiana Nevada Washington Iowa North Carolina West Virginia Kansas Oklahoma

2001 INTRODUCTIONS OF REVISED ARTICLE 9:

Arkansas Missouri Pennsylvania Colorado New Hampshire Oregon Georgia New Jersey US Virgin Islands Massachusetts New Mexico Wisconsin Mississippi North Dakota Wyoming

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