This article was published in the August 23, 2018 issue of Middle Market Growth, a weekly newsletter published by Association of Corporate Growth (ACG). It is reprinted here with permission.

On May 8, the U.S. Bankruptcy Court for the Western District of Missouri in In re 8760 Service Group held that a creditor had a first-priority interest in certain collateral of a debtor, before a subsequent creditor, despite an ambiguous collateral description in the UCC-1 financing statement. The court held that, because the ambiguity put the subsequent creditor on notice, that the subsequent creditor should have inquired into the extent of the prior creditor’s lien and that the prior’s creditor’s lien was properly perfected.¹ The case provides important guidance to private equity companies, including:

• In an acquisition, a private equity company should consider itself on notice, in the face of an ambiguous Uniform Commercial Code (UCC) financing statement, to inquire into the extent of a prior creditor’s lien filed against the seller and the target.
• If a private equity company is investing in a target as a 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 while avoiding addresses.

Background

The debtor, 8760 Service Group, LLC, operated a custom industrial construction and fabrication business, with a business office located at 1803 W. Main Street, Sedalia, MO. Bancorpsouth Bank was 8760’s primary lender. In 2014, Bancorpsouth filed a UCC-1 financing statement to perfect its lien. The statement identified the collateral as all of the debtor's accounts receivables, inventory and equipment located at 1534 Redwood Drive, Sedalia, MO 65301, which was the home of 8760’s member.

In 2015, Bancorpsouth filed a UCC-3 financing statement amending the description of the collateral to “all accounts receivable, inventory, equipment and all business assets, located at 1803 W. Main Street, Sedalia, MO 65301,” with a further description on the second page of the UCC-3 financing statement of "the above collateral, whether now owned or hereafter acquired, together with all supporting obligations, proceeds, products, software, accessories and accessions, including, but not limited to the items listed." The 1803 W. Main Street business office address provided in the amended UCC-3 financing statement held few assets.

In 2016, Hudson Insurance Company provided payment and performance bonds to 8760. To secure the bonds, Hudson took a security interest in all of 8760’s property and filed a UCC-1 financing statement in 2017 against 8760’s inventory, equipment and accounts. At dispute in In re 8760 Service Group was whether Bancorpsouth or Hudson held the first priority security interest in 8760’s equipment and inventory.

Analysis

Bancorpsouth asserted that the collateral description was an unambiguous blanket security interest in all assets regardless of location and that, even if there was some ambiguity, the financing statement was sufficient to serve as a notice filing and trigger a duty on the part of the subsequent creditor to investigate further. Bancorpsouth claimed its financing statement sufficiently indicated the collateral that it covered and that it was not seriously misleading. A financing statement substantially satisfying part 5 of the UCC is effective, even if it has minor errors or omissions, unless the errors make the financing statement seriously misleading (UCC § 9-506(a)). Bancorpsouth claimed that the collateral description in the amended UCC-3 financing statement could reasonably be interpreted two ways: either the address restricts all collateral or the commas and the addition of the second "all" limit the address restrictor to only the business assets.

Hudson and 8760 argued that the collateral description in Bancorpsouth’s financing statement was seriously misleading and ineffective to put a subsequent creditor on notice to inquire further because it was plain and unambiguous as to the limited scope of the covered collateral. Hudson and 8760 contended that the collateral description in Bancorpsouth's amended financing statement referenced a specific address location — the office address — which restricted the collateral to that location. The financing statement did not indicate “all assets or property,” which is the common method.

Outcome

The court cited ProGrowth Bank, Inc. v. Wells Fargo Bank, N.A., 558 F.3d 809 (8th Cir. 2009), in holding that the wording of the collateral description in the financing statement was sufficient to put Hudson on notice that it should inquire into the extent of Bancorpsouth's lien. Because the collateral description in Bancorpsouth's financing statement could "reasonably be interpreted in one of two ways — one of which may cover the collateral at issue and one of which does not," Hudson should have had an indication that its collateral may have already been covered by another creditor’s financing statement and the burden was on Hudson to further inquire whether it was primed. The court noted that a “reasonably prudent creditor” should consider itself on notice when there is an additional collateral description within a financing statement pointing to the possible existence of a prior lien. The court also held that Bancorpsouth's collateral description in the financing statement was not seriously misleading. Because Bancorpsouth filed before Hudson, Bancorpsouth held a first-priority security interest in 8760’s equipment and inventory.

The Takeaway

Private equity companies can take important lessons from this case. In an acquisition, a private equity company should review UCC lien searches for financing statements filed against the seller and the target. If there are any ambiguous UCC financing statements, the private equity company should inquire into the extent of a prior creditor’s lien and resolve the lien to the private equity company’s satisfaction. If a private equity company is also investing in a target as a 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 while avoiding addresses.

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