This article was published in the October 25, 2018 issue of Middle Market Growth, a weekly newsletter published by Association of Corporate Growth (ACG). It is reprinted here with permission.

On August 20, the U.S. Bankruptcy Court for the Central District of Illinois in In re I80 Equipment, LLC, No.17-81749, 2018 WL 4006294 (Bankr. C.D. Ill. Aug. 20, 2018) held that a secured party failed to perfect its security interest due to an insufficient description of the collateral listed in its UCC-1 financing statement. The financing statement failed to sufficiently describe the collateral because it referenced the definition of “collateral” in the underlying security agreement without attaching the security agreement to the financing statement. The case provides important guidance to private equity companies, including:

• If a private equity company invests in a target as a secured creditor, the private equity company should avoid ambiguous collateral descriptions in its UCC-1 financing statements.

• Collateral descriptions in UCC-1 financing statements should include super-generic descriptions (such as “all assets of the debtor”) while avoiding reference to definitions in an underlying agreement.

• If collateral descriptions in UCC-1 financing statements refer to definitions in an underlying agreement, the underlying agreement must be attached to the financing statement.

Background

The debtor, I80 Equipment, LLC, operated a commercial business that purchased and refurbished bucket trucks for resale. In 2015, First Midwest Bank made a commercial loan to I80. I80 granted a security interest in substantially all of its assets to First Midwest Bank via a First Amended and Restated Security Agreement. First Midwest Bank filed its UCC-1 financing statement with the Illinois Secretary of State, describing the collateral as “All Collateral described in First Amended and Restated Security Agreement dated March 9, 2015, between Debtor and Secured Party.” The security agreement was not attached to the financing statement.

In 2017, I80 defaulted under the terms of the loan and petitioned for Chapter 7 relief. As a result, First Midwest Bank brought a declaratory judgment against I80. First Midwest Bank sought a judgment that its security interest was properly perfected and senior to all other claimants. The bankruptcy trustee denied that the security interest was properly perfected and asserted an amended counterclaim to avoid the lien.

Analysis

The key issue is whether a collateral description in a filed financing statement that refers to an unfiled document sufficiently indicates the collateral as required by the Uniform Commercial Code to achieve perfection. There are two ways to sufficiently indicate the collateral under the UCC. Section 9-504 provides that a financing statement sufficiently indicates the collateral if it provides one of the following:

• a description of the collateral pursuant to section 9-108 (by specific listing, category, type of collateral defined in the UCC, quantity, formula or procedure, or any other method if the identity of the collateral is objectively determinable)

• an indication that the financing statement covers all assets or all personal property (i.e., the “super-generic description”).

First Midwest Bank argued that its collateral description was sufficient to perfect its security interest under the UCC because the description reasonably identified the collateral by “any other method” and the “identity of the collateral is objectively determinable.” Thus, the description placed subsequent creditors on notice that I80’s property was subject to a lien and further inquiry may be needed.

The trustee argued that the financing statement was deficient under the UCC because it contained a mere inference to the collateral that “does not suffice to indicate, describe, or reasonably identify any collateral.” The trustee argued the financing statement made no attempt to reasonably identify the collateral.

The court conceded that, because the security agreement and the financing statement have different purposes, different standards apply to the collateral descriptions in the two documents. According to the court:

The requirement that the security agreement reasonably describe the collateral serves an evidentiary purpose, that is to create an enforceable security interest in clearly identified property of the debtor and to set forth enforceable contract terms and covenants respecting that interest and the collateral. The purpose of a financing statement is to put their parties on notice that the secured party who filed it may have a perfected security interest in the collateral described, and the further inquiry into the extent of the security interest is prudent.

The court acknowledged that a financing statement is not required to specify the collateral as the security agreement must, and a financing statement may be abbreviated or streamlined to provide notice to third parties. However, the court agreed with the trustee that the financing statement did not sufficiently describe the collateral because the description on its face did not provide any information or any notice to third parties about the collateral for the security interest. The court elaborated that a financing statement that does not contain any description of collateral fails to provide the required notice as the starting point for further inquiry.

The court also stated that a financing statement may not be supplemented by outside evidence or by reference to an unfiled security agreement. According to the court, extraneous evidence is not admissible in a priority dispute to correct errors and omissions in a financing statement or to clarify ambiguities.

Outcome

The court held that First Midwest Bank did not sufficiently describe the collateral in its financing statement by reference to an unfiled document, thus failing to perfect its security interest in the collateral. As a result, the trustee was entitled to judgment on the pleadings.

Takeaway

Private equity companies can learn important lessons from this case. If a private equity company is investing in a target as a secured creditor, when perfecting its security interest, the private equity company should include super-generic descriptions, such as “all assets of the debtor,” while avoiding reference to definitions in an underlying agreement. The private equity company should ensure that the financing statement contains a description that reasonably identifies the collateral and that the description is contained within the four corners of the document. The financing statement should include a full description of the collateral or reference an attached document that contains the description.