Dedicated To Partnering With Our Clients Banking & Financial Institutions Group Newsletter • February 2002 • Volume 3 OUR COMMITMENT TO OUR CLIENTS Security Interests in Accounts Receivable Partnering and Inventory in Common Law and We are an essential part of our Civil Law Jurisdictions clients’ success, working every day to enhance our clients’ business relationships by making Secured lenders, especially working capital rarely give any weight to US law security available our substantial contacts lenders, are no doubt familiar with the frame- documents, secured lenders should be in the business community. We work of secured lending laws provided by aware of the differing forms of legal sys- are partners in the broadest sense Article 9 of the Uniform Commercial Code tems and security interest rules they may with our clients; ensuring their (“UCC”). The UCC, designed to facilitate com- face in cross border lending transactions. financial success is a core part of mercial transactions, governs the creation, For ease of illustration we will examine the service that we provide. perfection and enforcement of security inter- how such legal systems treat the type of ests in personal property. The salient features collateral that secured lenders are most Efficiency and Practicality of the UCC that permit this are (i) security in- familiar with, Liquid Collateral. terests in personal property not limited to spe- We provide practical, results cific existing assets, rather attaching to entire oriented advice, with a view Differences Between Common and Civil towards bridging differences and categories or types of assets, whether of a static Law Legal Systems nature such as fixtures on specific real prop- closing transactions efficiently The UCC is an outgrowth of the common and economically. erty, or of a type constantly changing such as accounts receivable and inventory (“Liquid law legal system. This system originated in old English law and has a tradition of de- Partner Responsibility Collateral”), (ii) a uniform filing system for the perfection and public notification of the exist- velopment based on court decisions and Partners are responsible for ence of liens to creditors, (iii) a prioritization the legislative process. In this system the structuring transactions, negotiat- of competing security interests or claims and legislature adopts a law and the courts are ing and drafting all significant (iv) a uniform set of rules for enforcement of left to interpret, clarifying the law’s mean- documents and closing all deals. security interests in personal property. ing and in many instances expanding the law’s scope. Due to this duality of change World Class Experience When dealing with security interests in as- mechanism, common law is thought to be The Financial Services Group has sets in foreign countries a secured lender will more readily adaptable to changing circum- broad practice experience in all find that many of these UCC principles are aspects of bank and institutional not found in local law. As foreign courts will continued on page 2 lending transactions, including cash flow and asset based lending, project and limited recourse U.S. OFFICES financings, large and middle Atlanta, Georgia • Baltimore, Maryland • Charlotte, North Carolina • Charlottesville, Virginia market cap financings, senior, subordinated and mezzanine Chicago, Illinois • Jacksonville, Florida • New York, New York • Norfolk, Virginia financings, investment grade and Pittsburgh, Pennsylvania • Richmond, Virginia • Tysons Corner, Virginia • Washington, D.C. leveraged transactions, domestic and cross-border deals and INTERNATIONAL OFFICES “work-out’ and debtor-in- Almaty, Kazakhstan • Brussels, Belgium • Moscow, Russia (of counsel) possession financings. www.mcguirewoods.com Security Interests in Accounts Receivable and Inventory continued from page 1 stances and has developed a more flexible approach to secured lender providing working capital financing against commercial transactions. In contrast, in the civil law sys- Liquid Collateral. As a corollary, this specificity would tem the legislature alone creates and changes laws - the not permit a security interest in an account receivable court systems’ only responsibility is to apply and enforce not yet created. For inventory this requirement would the law instead of interpreting it to fit varying situations entail a description of location, quantity and type. Again, and contexts. As a result, it is thought that the civil law this requirement is not conducive to a business where system is much less adaptable to changing times and cir- inventory is constantly turning over and may pass through cumstances, as with the case of laws governing commer- several locations that the Borrower uses to manufacture, cial transactions. Set forth below is a brief general de- distribute and sell inventory. scription of the ways in which civil law systems vary from the UCC in their treatment of security interests in Liquid Lien Registration/Perfection of Lien Collateral. In addition, we have included specific ex- amples of the application of common law and civil law Under the UCC, a secured lender receives a grant of a principles in dealing with the creation, perfection, rank- security interest for Liquid Collateral pursuant to a se- ing and enforcement of security interests in Liquid Col- curity agreement and perfects that security interest by lateral in three commercially important countries: the making a single filing in the Borrower’s jurisdiction of United Kingdom (which follows the common law sys- organization with the secretary of state’s office. This fil- tem); and France and Germany (which follow the civil ing also serves the purpose of giving national notice to law system). all claimants of the existence of a security interest in the Borrower’s Liquid Collateral. Specificity Requirement/Floating Liens In contrast, most civil law jurisdictions lack a central filing system for perfection or notice of liens. Instead, Under the UCC a security interest may be created in heavy reliance on actual notice of the lien to third par- broadly described categories of assets, such as “accounts ties, such as a requirement to directly notify an account receivable” and “inventory”. There is no requirement debtor of the existence of a lien on accounts receivable, that individual items of collateral be identified or that is required. In the case of inventory, although some ju- the borrower (“Borrower”) even have rights to collateral risdictions may have a rudimentary filing system, the at the time it grants the security interest. These are the preferred method (and sometimes the only practical principles of the “Floating Lien”, or a lien that attaches method) of establishing the lien and its perfection against to a type of collateral that by its nature is constantly third parties is for the secured lender to take physical changing, for instance through the turnover of inven- control of the inventory. In short, these limitations on tory or the creation and collection of accounts receiv- perfection and notice to claimants coupled with the lack able. In addition, this security interest applies to all such of a viable Floating Lien concept make secured lending property in which the Borrower has rights whether these against Liquid Collateral very unattractive in civil law rights exist in the present or arise in the future (the “after jurisdictions. acquired property” concept). The UCC specifically pro- vides that the Borrower may create such a property in- terest in an account receivable even if the account debtor Priority of Perfected Secured Interests desires to restrict the right of the Borrower to do so. The UCC provides a uniform set of rules for determining In contrast, under the civil law system, the concept of a the priority of liens of competing claimants. In contrast, Floating Lien is either nonexistent or, due to the strict limi- under the civil law system, due to the lack of a central- tations put on this security device, is of little practical ized filing and notification system, a secured lender may value to a secured lender. Civil law countries typically have to rely solely upon the good faith representation of require that collateral be specifically described. For ac- the Borrower as to the existence and/or priority of com- counts receivable, this may mean a detailed description peting claims. This last point is illustrated by the civil including date incurred, name of account debtor and law’s recognition of a supplier’s right of retention of title. amount. This requirement may work for a limited group- Under the UCC, in order to retain title to inventory trans- ing of existing accounts, but would not be workable for a ferred to a Borrower, a supplier must file a financing 2 Banking & Financial Institutions Group Newsletter statement to perfect and publicly disclose its security collect payments directly from account debtors. In con- interest. In many European countries, the supplier con- trast civil law jurisdictions generally require the use of a tinues to own the goods after they are received by the court appointed receiver to foreclose on collateral that Borrower and the supplier’s rights continue until the sup- is not in the secured lender’s possession. As this receiver plier is paid for the goods sold. Furthermore, a supplier’s typically answers to the court, a secured creditor may right of retention of title has priority over the inventory have no control over disposition of its collateral, and security interests