Commercial loan transactions which are secured by personal property assets require the completion of certain due diligence under the Uniform Commercial Code (the "UCC"). As any experienced commercial lender knows, the lender must obtain UCC searches of the party or parties that will grant a security interest (the "Debtor") to the lender. Assuming these searches are performed using the proper name of the Debtor, and in the proper governmental office or offices, the lender will have available to it the information it needs to assess whether, and to what extent, such property is subject to a prior, conflicting security interest. Typical UCC search results will show:
Filing information (including the date of filing, the name of the secured party and the filing number) for each original UCC financing statement filed against the Debtor;
Filing information, if applicable, for any amendments and/or continuation statements; and
Filing information for any termination statements that may have been filed.
Protect Yourself from Unauthorized Termination Statements
However, unauthorized termination statements could lead to serious, unexpected consequences with respect to a lender's security interest priority. Lenders and their counsel should take care to review any and all termination statements that are included in the UCC search results very closely, and should discuss what additional steps may be advisable to confirm the propriety of such termination statements. Failure to do so could result in the lender inadvertently putting itself in an inferior position with respect to its collateral. Generally speaking, only the secured party of record is authorized to file a UCC termination statement. A debtor may file a termination only in limited circumstances, including where the secured party fails to file or send the debtor a termination statement following the debtor's request after payment in full of the secured obligations. Thus, lenders should scrutinize any terminations that are included in their UCC search results and take additional steps to confirm that the applicable termination statement was properly authorized and filed.
The steps may include:
Determine whether the termination statement itself indicates that it was filed by the debtor, as opposed to the secured party;
Review the debtor's financial statements to determine whether the secured party identified in such termination statement remains a creditor of the debtor, and discuss the same with the debtor; and
Contact the secured party for direct confirmation that it is aware of, filed, and/or authorized the filing of the termination statement.
A recent case applying New York's UCC, AEG Liquidation Trust v. Toobro NY LLC, addressed the impact of an unauthorized termination statement on a subsequent secured party, and held that the obligation to determine whether or not a termination statement has been properly filed rests with the subsequent lender. In that case, the original lender's UCC financing statement was terminated pursuant to a termination statement filed by the debtor.
Three years later, before the original lender discovered that the termination statement had been filed, a new lender made loans to the debtor and filed a UCC financing statement, relying on the filed termination statement. In the ensuing priority battle between the two lenders, the court determined that the termination statement filed by the debtor was unauthorized and of no legal effect at all. As a result, the original lender's UCC filing remained effective and had priority over the subsequent lender's filing.
In this case, the termination statement itself indicated that the debtor, not the secured party, had filed it. Because the circumstances under which a debtor is authorized to file a termination statement are so limited and unusual, this should serve as a "red flag" to subsequent lenders, and warrants further inquiry of the debtor and, perhaps, the secured party named on the earlier financing statement.
Lenders should also consider making inquiry of the debtor as to all termination statements that are included in their UCC search results. As the Toobro case illustrates, failing to determine that a termination statement was authorized by the proper party could result in a lack of expected priority for a subsequent lender.