Inside M&A - Summer 2013

by McDermott Will & Emery
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In This Issue:

A Closer Look at Leveraged Dividend Recapitalizations

2013 Six-Month Credit Markets Trends

A View of the Bridge: M&A Bridge Loans Explained

What’s in a Name?  In the Secured Lending World, Just About Everything

A Closer Look at Leveraged Dividend Recapitalizations
by Michael Boykins and Joseph L. Devaney

With merger and acquisition activity down over the course of 2012 into 2013, and a weak market for initial public offerings (IPOs), many private equity firms have turned to leveraged dividend recapitalizations (recaps) as a means to extract value from their portfolio companies and create partial liquidity for distributions to their limited partner investors.  A leveraged dividend recap may also be pursued when an equity investor seeks to realize value from its investment in a private company without selling or diluting its equity interests.  Unlike a typical dividend that is paid from a company’s earnings, a leveraged dividend recap is a type of transaction often used by private equity firms that results in the replacement of a portion of a firm’s appreciated equity investment in a portfolio company with debt (typically bank debt or the issuance of bonds) on the portfolio company’s balance sheet and the distribution of the proceeds of such debt to the portfolio company’s equity holders. 

Recent Resurgence and Motivation for Leveraged Dividend Recaps

Leveraged dividend recaps have grown in popularity over the last decade among private equity firms, peaking in 2007 prior to the start of the global financial crisis.  Starting in early 2010, the number of leveraged dividend recap transactions was once again on the rise.  According to Standard & Poor’s (S&P) Capital IQ LCD report, in 2012, private equity portfolio companies borrowed more than $64 billion in debt to pay dividends to their equity holders, which is nearly double the volume of debt incurred by portfolio companies for leveraged dividend recaps in 2011, and, through the end of April 2013, portfolio companies had borrowed almost $20 billion to finance equity holder dividends, which is comparable to the amount of borrowing for the same period in 2012.  However, according to a recent S&P report, 14 proposed leveraged dividend recap transactions collapsed in June 2013 following a general cooling in the loan markets after the Federal Reserve’s announcement that it could begin to slow its bond-buying program.  This suggests that the resurgence of leveraged dividend recaps may be slowing as we head into the second half of 2013.  Similarly, a recent Moody’s report indicates that it does not believe the pace of leveraged dividend recaps will continue in 2013 because of the resolution of the fiscal cliff tax issues on January 1, 2013.  Several deals that have come back to the market reflect pricing and covenant terms that are much more lender friendly than when these transactions were first launched.

Private equity firms benefit from leveraged dividend recaps in a number of ways, including the following:

  • A firm’s internal rate of return on an investment is accelerated.
  • There is no dilution of ownership in the portfolio company—the private equity firm maintains operational control of the company while pulling out part, if not all, of the firm’s initial investment.
  • Private equity firms are positioned to capture the full benefit of future portfolio company growth when the firm exits its investment in the portfolio company via a sale or an IPO.
  • Interest payments by the portfolio company on the newly issued debt are tax deductible.

In addition to the benefits described above, the resurgence of leveraged dividend recaps over the course of 2012 and into May 2013 can specifically be attributed to following market conditions:

  • Generally improved lending environment making it easier for companies to borrow
  • Expected end of the “Bush-era” tax cuts and increases in the federal capital gains and dividend tax rates at the end of 2012
  • Investors seeking high-yielding debt instruments during this period of historically low interest rates
  • Relatively stagnant merger and acquisition activity and IPO market resulting in excess available liquidity to finance dividends

Risks of Leveraged Dividend Recaps

Private equity firms should consider the risks and potential consequences prior to consummating a leveraged dividend recap.  Most significantly, entering into such a transaction creates additional debt for a portfolio company without any increase in cash flow or revenue, which could hinder a company’s ability to fund day-to-day working capital needs, cause a company to lose sight of its long-term strategic goals by focusing on generating immediate cash flow, or put a company into bankruptcy.  A recent study by S&P of leveraged dividend recap transactions completed in 2012 and through April 2013 found that, on average, private equity firms were able to extract 55 percent of their initial capital contribution through a leveraged dividend recap while increasing leverage on the portfolio companies by 1.3 turns of EBITDA.  In some instances, the increased leverage has prompted a credit ratings downgrade, leading to questions about the long-term viability of certain portfolio companies in the event of an economic recession or slow down.     

If the portfolio company making a leveraged dividend is insolvent, or rendered insolvent by paying the dividend, the transaction may be set aside by a court as a fraudulent conveyance.  Fraudulent conveyance laws, which exist under both federal and general state laws, were established to prevent secured creditors, equity holders and other interested parties of a company from financially benefitting at the expense of unsecured creditors.  Two types of fraudulent conveyance claims exist:

  • A conveyance made with actual intent to hinder, delay or defraud creditors
  • A conveyance deemed to be constructively fraudulent because it is made for less than reasonably equivalent value while a debtor is (a) insolvent or rendered insolvent as a result of the transaction, (b) undercapitalized or (c) otherwise unable to pay its debts as they become due  

The consequences of a fraudulent conveyance can be severe, as courts have been known to unwind transactions (i.e., repayment of the dividend paid to the equity holders) and void security interests, and lenders and directors can face liability for their involvement in leveraged dividend recaps that are characterized as fraudulent conveyances.

Protective Measures

As a result of these risks, lenders, directors and private equity firms have increasingly turned to a solvency opinion from an independent financial advisor to demonstrate that a company will remain solvent immediately following a leveraged dividend recap after taking into consideration the debt incurred as part of the transaction.  A typical solvency opinion applies three financial tests: a balance sheet test, a cash flow test and a capital adequacy test, each of which must be satisfied in order for a company to be considered solvent.  In addition, certain states may require that dividends be paid out of capital surplus.  For example, in Delaware, a capital surplus is deemed to exist if the fair value of a company’s assets exceeds the sum of its liabilities and the total par value of the company’s issued capital stock.  In such cases, it may be prudent to receive a capital surplus opinion to support a company’s position that the amount of the proposed dividend would not exceed the company’s statutory capital surplus.

In addition, company directors must exercise their duties of care and loyalty to the company, not to the private equity firm owners and other investors, when considering whether or not to approve a proposed leveraged dividend recap.  This means directors must consider all relevant information and exercise all necessary corporate governance measures to determine whether it is in a company’s best interests to effect a dividend recap, which may include conducting a formal board meeting with presentations from officers of the company and outside advisors, as well as the formation of a special committee of the board of directors with independent directors charged with the task of evaluating the merits of a leveraged dividend recap.

Leveraged dividend recaps remain an effective tool for private equity firms to achieve partial liquidity from their investment before a portfolio company is ready for an IPO or to be sold.  Over the past year, many private equity firms have used leveraged dividend recaps to enhance their internal rate of return on investments, particularly portfolio companies that became “over-equitized” during the credit crisis of 2008 and 2009.  However, like any leveraged transaction, leveraged dividend recaps have risks, including bankruptcy, a fraudulent conveyance characterization or a payment of a dividend when insufficient capital surplus exists, which can result in liability for directors.  Private equity firms, directors and equity holders can significantly mitigate these risks by obtaining a solvency opinion from an independent financial advisor and adhering to required corporate governance measures when considering whether to consummate a leveraged dividend recap.

2013 Six-Month Credit Markets Trends
by Michael Boykins

Despite some correction in the credit markets in favor of investors and lenders in the second quarter of 2013—particularly in June following the Federal Reserve’s announcement that it will begin to taper its bond-buying program later in the year if economic growth meets expectations—the first half of 2013 continued to be a strong leveraged loan market for issuers.  There continues to be an oversupply of capital for available transactions in many asset classes.  Leveraged loan volume totaled approximately $350 billion over the first half of 2013, an approximate 75 percent increase over the same period for 2012.  Middle-market loan volume also increased for the same period year-over-year by approximately 44.5 percent, from approximately $4.5 billion to approximately $6.5 billion.  Most leveraged loan activity continued to be dictated by refinancings, primarily repricing amendments and extensions, and continued strong activity for leveraged dividend recaps for most months during the period (other than June, which saw at least 16 dividend recap transactions pulled from the market) as mergers and acquisitions activity remained soft.  Similarly, the high-yield bond market was severely disrupted by the Federal Reserve’s announcement causing outflows of available capital for high-yield investments into other asset classes, resulting in an overall decrease of approximately 9.5 percent in new issuances of high-yield bonds in the second quarter to approximately $81 billion. 

The first half of 2013 saw attractive pricing for issuers as a result of the continued strong demand by investors looking to deploy capital.  Pricing spreads for single B-rated issuers increased from approximately L+372 to L+416 as compared to BB-rated issuers, which saw spreads increase from approximately L+265 to L+308 during this period.  In June 2013, refinancings driven by pricing concessions were limited as lenders were less receptive to giving the requested concessions.  In comparison, middle-market spreads for the last 90 days on first lien debt has run approximately L+562.  The ultimate impact of the June correction on the middle market, which tends to react more slowly than the broadly syndicated market, has yet to be determined.

Covenant-lite loans as a percentage of financings in the institutional market have shown a downward trend from the first quarter to the second quarter of 2013.  Covenant-lite loans are loans that may have one or more of the following features:  

  • No maintenance covenants (such as financial covenants) or maintenance covenants that only apply to, or are for the benefit of, the revolving lenders in the loan facility (which may be “springing covenants” when certain outstanding borrowing levels are reached); or, if the maintenance covenant is not completely eliminated, establishing covenant cushions from the issuer’s projections that are more generous than the typical 20 percent to 25 percent cushion
  • An incurrence test (e.g., compliance with a leverage test or interest coverage test at the time of the incurrence of debt, but no requirement to maintain compliance after it is incurred)

Institutional deals that contained covenant-lite structures represented approximately 44 percent of financings in the second quarter of 2013, down from approximately 57 percent in the first quarter of 2013, with June slipping to approximately 27 percent.  However, this volume far exceeded the number of covenant-lite deals in 2012, increasing from approximately 52 loan transactions to approximately 200, an increase of approximately 285 percent.

Sponsors continued to drive leveraged dividend recap loan volume during the first half of 2013.  Sponsor-backed issuers represented approximately 77 percent of dividend recap loan financings, approximately $35 billion.  Total dividend recap volume for the first half of 2013 totaled approximately $46 billion as compared to $32.2 billion for the second half of 2012.  This is contrary to predictions by some market observers that the volume may trend downward in 2013 as a result of what many believed was an acceleration of dividend recap financings into the latter half of 2012 because of uncertainty regarding U.S. tax policy, fiscal cliff concerns, etc.  Notwithstanding the June 2013 correction and the downward impact it had on dividend recaps, second quarter dividend recap volume increased overall from approximately $17.8 billion in the first quarter of 2013 to approximately $27.8 billion, a 56.2 percent increase.

Issuers looking to finance in the asset-based lending market will find that pricing remains competitive.  Volume is up slightly in the second quarter of 2013 (approximately $2.6 billion) over the same period in 2012 (approximately $2.5 billion), but down approximately 60 percent when compared to volume in the first quarter of 2013 of approximately $6.5 billion.  Retail food and drug (approximately 28 percent), food and beverage (approximately 16.7 percent), services and leasing (approximately 10 percent), building materials (approximately 9.5 percent) and forest products (approximately 7 percent) were the five most active sectors for asset-based lending facilities in the first half of 2013.

Collateralized loan obligation (CLO) issuances continued to decline in the second quarter of 2013 to approximately $16 billion from $26.3 billion in the first quarter, a decline of approximately 40 percent.  Lack of collateral supply and acceleration of transactions into March 2013 in front of the new Federal Deposit Insurance Corporation (FDIC) rules that were to take effect in April requiring banks to apply higher capital requirements to AAA CLO paper were the main drivers of this decline.  The new FDIC rules (resulting in less demand by banks for senior liabilities) caused AAA CLO liabilities spreads to widen to L+110–115 by the end of June from L+130 for earlier periods in the year.  Likewise, CLOs’ share of the overall primary market was reduced to approximately 53 percent, down from approximately 60 percent in March.

It remains to be seen if the June correction will have long-term effects on the second half of 2013.  In the short run, continued oversupply of capital should make for an accessible leveraged loan market for issuers.  Pricing and structure of financings may continue to move in favor of investors, but should still provide issuers the flexibility desired to complete financing transactions.  As private equity firms’ expectations related to dividend recap financing pricing and structures settle, we should continue to see the use of this financing vehicle by private equity firms to harvest value from portfolio companies.

Sources: Standard & Poor’s Leveraged Commentary & Data and KPMG Corporate Finance

A View of the Bridge: M&A Bridge Loans Explained
by John Hammond

Bridge loan financing for mergers and acquisitions involves high stakes for borrowers and lenders.  Understanding the timing, structure, terms and range of outcomes under a bridge loan commitment is key to a successful financing negotiation and to analyzing the overall transaction economics.

For corporations and private equity sponsors pursuing large acquisitions, securing a bridge loan commitment may be the final component to a winning acquisition bid.  While in many cases the borrower and the committing bridge lenders view the bridge commitment as a backstop and share the goal of never actually having the bridge loan funded, the terms can be of critical importance to the overall economics of the acquisition and to the timing, structure and terms of a long-term financing.  The complexity of bridge loan terms, and the broad range of potential outcomes that may follow a bridge loan commitment, make it imperative for an acquirer to promptly engage in careful negotiations with the bridge loan providers and to factor the bridge financing costs and terms into its economic analysis and projections for the acquisition.

The Financing Gap and a Bridge Loan to Cross It

In the current merger and acquisition environment, acquisition targets in middle market and large cap transactions will rarely accept a financing contingency in an acquisition agreement.  Acquisition targets will closely analyze a bidder’s financing sources to assess the likelihood that a bid, once accepted, will result in a consummated acquisition.  This presents obvious difficulties for a potential acquirer that does not have an existing credit facility or cash sufficient to finance the subject acquisition.  The challenges are particularly acute for transactions in which a bidder expects ultimately to finance the acquisition in whole or in part through new debt financing in the capital markets, through a high-yield debt offering or a broadly syndicated loan facility, where a number of factors, including confidentiality requirements, bid uncertainty, capital market conditions and transaction timing, may prohibit securing such financing in advance of announcing an acquisition. 

Bridge loan financing offers a solution to fill the gap between the time a purchase agreement is signed and the time at which long-term financing can be obtained, and is sometimes the only practical option for an aspiring acquirer to secure a winning bid.  Although the bridge loan, if it is actually funded, is necessary for purposes of financing the payment of the purchase price on the closing date, it is the bridge loan commitment, which is invariably provided by an investment bank (or its affiliates) regarded as highly creditworthy, that provides the critically needed assurance to the acquirer that financing will be available for the acquisition on the closing date regardless of whether a capital markets transaction can be completed by that time, and to the target that the transaction will not fail to close as a result of a lack of financing.

A unique aspect of bridge loan financing is that the investment banks (or their affiliates) providing the bridge loan commitment typically do not wish to participate in the long-term financing as debt holders, and seek to reduce or eliminate the significant risk associated with a funded bridge loan.  Instead, investment banks commit to bridge financing so that they may be engaged to arrange the long-term financing and, in many cases, to facilitate the underlying acquisition for which they may also be involved, each of which offers significant fee income to the investment bank.

Structure of Bridge Loans

Bridge loans are typically short-term facilities used to bridge a financing gap until the borrower is able to obtain long-term financing from the capital markets or another takeout.  Similar to other loans, interest rates for bridge loans vary depending upon the credit rating of the borrower or its debt.  However, bridge loan interest rates tend to be higher than rates applicable to other forms of financing, and such rates typically increase periodically over the initial term of the loan.  For example, a bridge loan with an initial term of one year likely will have an upward interest rate change on a quarterly basis.  Interest rates will normally be subject to a cap, though the bridge lenders may also require a floor.  Bridge lenders may also allow for non-cash or payment-in-kind interest payments, which also may be subject to a cap.

Maturity

If the borrower does not pay off a bridge loan at the end of its initial term, the bridge loan will automatically convert into a long-term financing either in the form of a bond or a term loan with a longer maturity (e.g., five to 10 years) and a higher interest rate (typically the interest rate at the end of the initial term plus an additional premium).  To facilitate conversion of the bridge loan into bonds, the bridge lenders may require the borrower to file a shelf registration with respect to these exchange securities prior to the end of the initial term.  In addition, the bridge lenders may also require the borrower to pay liquidated damages equal to a percentage of the principal amount of the exchange securities if the exchange securities are not freely tradeable at the end of the initial term.

Fee Structure

To compensate bridge lenders for the short-term nature of a bridge loan, commitments often include myriad fees, some of which have the potential to overlap.  Fees may include the following:

  • A commitment fee is a fee for the bridge lenders’ commitment, payable whether or not the bridge loan is funded.
  • A funding fee is a fee for funding the bridge loan, payable on the date that the bridge loan funds (typically on the closing date).  If a bridge loan is refinanced before maturity, some bridge lenders may be willing to partially refund the funding fee depending upon the time between the funding and the repayment.  These rebates range from 75 percent to 25 percent depending on the time period after which the refinancing of the bridge loan occurs.  The shorter the period of refinancing after funding, typically the higher the discount.  For example, the bridge lenders may be willing to refund 75 percent of the funding fee if it is refinanced within 30 days of funding, 50 percent if it is refinanced within 60 days of funding, or 25 percent if it is refinanced within 90 days of funding.  Outside time frames for rebates vary and may be as long as 270 days.
  • A deal-away fee is a fee to the bridge lenders on the closing date in the event another source of financing is used.  Typically the fee is intended to compensate the bridge lenders for the fees that they would have otherwise received had the bridge loan funded.
  • If the bridge loan is syndicated, the lead bank is usually appointed as the administrative agent and receives an additional administrative agent’s fee when the bridge loan funds, then typically annually thereafter for as long as the bridge loan is outstanding.
  • A duration fee is a periodic fee on the outstanding balance of the bridge loan, sometimes increasing the longer the bridge loan remains outstanding.
  • If the bridge loan is not refinanced by the end of its initial term and converts into long-term financing as discussed previously, bridge lenders often will require an additional conversion/rollover fee to compensate them for continuing the bridge loan under the new financing structure.  Fees are typically equal to an underwriting fee that would have been paid had the bridge loan been replaced in a bond offering.  Similar to the funding fee, the conversion/rollover fee may also be subject to rebate depending on when the bridge loan is repaid after the end of the initial term of the bridge loan.
  • A refinancing fee is a fee payable when the bridge loan is refinanced prior to its initial term.  Typically, the refinancing fee is equal to the conversion/rollover fee.
  • A bond underwriting fee is a fee for underwriting a bond offering to replace the bridge loan, typically documented separately from the bridge loan commitment.

Careful attention should be paid when negotiating bridge-loan-related fees to avoid potential overlap.  For example, the refinancing fee could overlap with the bond underwriting fee in cases in which the bond offering is placed by the same investment bank that issued the bridge loan.  Similarly, the refinancing fee may potentially overlap with the deal-away fee if the deal-away fee provision is worded broadly to extend beyond the initial funding of the bridge loan.

Securities Demand

Often the most contentious provision when negotiating a bridge loan commitment is the securities demand, which provides the bridge lenders with the right to require the borrower to issue long-term debt securities into the capital markets to refinance the bridge loan.  Once the conditions for the securities demand are met, the investment bank, rather than the borrower, controls the timing to take the long-term financing to market.  Common points of negotiation include the following:

  • Timing.  A borrower may request to limit the bridge lenders’ ability to make a securities demand until some period after the bridge loan funds (e.g., up to 180 days after funding) to allow for flexibility to fund the bridge in case the price of long-term debt is higher at closing.  However, in recent years, borrowers have typically been unable to obtain such “holiday” periods from bridge lenders.  More commonly, securities demands are exercisable at closing, although bridge lenders also may require that the securities demand be exercisable pre-closing with the securities issued into escrow.
  • Number, frequency and minimum size of demands.  To limit the costs of multiple securities demands, borrowers may try to limit the number, frequency and minimum size of each demand.
  • Sale process requirements.  Often, borrowers will seek to obtain an obligation from the bridge lenders that they will obtain the best price for the securities offering or at least make a bona fide attempt (e.g., at least one road show).

Securities Demand Failure

Borrowers and bridge lenders also typically negotiate the remedies in case the securities demand fails to raise funds sufficient to repay the bridge loan in full.  In particular, bridge lenders will often request the ability to exercise any or all of the following remedies upon notice of a demand failure:

  • Increase in the bridge loan interest rate to the highest rate chargeable under the facility
  • Modification of bridge loan terms to include defeasance and call provisions customary in publicly traded high-yield debt so long as the failure continues
  • Default under the bridge loan so long as the failure continues
  • Payment of a conversion/rollover fee

Similarly, borrowers may seek to narrow the scope of the securities demand failure through a provision permitting the borrower to refuse a securities demand if it would result in potentially adverse tax consequences (e.g., cancellation of debt income or applicable high-yield discount obligations issues).

Terms of Long-Term Financing

Sponsors who have experience with negotiating fully underwritten commitment letters with one or more lead lenders and arrangers that intend to syndicate a significant part of an acquisition loan facility will be familiar with “market flex” provisions in fee letters that enable the committing lenders and arrangers to “flex” certain specified terms of the credit facility.  Such “flex” provisions apply as well to bridge loan commitments, in which underwriters seek broad discretion to vary the terms of the long-term financing to facilitate the syndication of the long-term credit facility or the placement of the long-term debt securities.  The scope of such flex rights can vary dramatically depending on conditions in the capital markets, sponsor relationship, leverage and issuer credit profile.  Among the many terms that may be subject to flex are price, structure flex (senior debt, senior subordinated, second lien tranches), maturities, financial covenants and financial covenant calculations.

Conclusion

A corporation or private equity sponsor negotiating a commitment for a bridge loan will invariably seek the best economic terms for the bridge facility and for the anticipated long-term financings.  However, as much or more focus is needed on limiting the downside risk by negotiating limits on the rights of underwriters to make securities demands and flex key economic and legal terms, and by understanding the impact of a downside case on financial projections for the acquisition.

What’s in a Name? In the Secured Lending World, Just About Everything
by Jean LeBlanc and Jessica Dombroff

Summertime is arguably the best time of the year.  Warm weather.  Long-awaited family vacations.  Extended daylight.  And unique to this summer, as of July 1, 2013, in most states, we have substantial amendments (the 2010 Amendments) to the Uniform Commercial Code (UCC) to digest (maybe even under an umbrella on the beach).  The 2010 Amendments are intended to clarify existing law, especially with respect to how certain types of debtors are named in financing statements.  As of July 3, 2013, 44 states and the District of Columbia had enacted the 2010 Amendments.  A chart at the end of the article indicates which jurisdictions have and have not adopted the 2010 Amendments.

This article provides an overview of the UCC rules governing proper debtor-naming conventions in financing statements for organizations (both registered and unregistered) and individuals after taking into account the relevant changes made by the 2010 Amendments.  

Location, Location, Location

Before addressing debtor-naming issues, it is important to understand the foundational issue of the debtor’s “location” as defined in the UCC.  Under the UCC, it is the jurisdiction of a given debtor’s location that is applicable to that debtor, and financing statement filings and searches must be done in that jurisdiction.

A debtor that is a “registered organization?? is located in the jurisdiction where it is incorporated or organized.  A registered organization is an organization formed or organized by the filing of a “public organic record” with, or the issuance of a public organic record by, a state or the United States.  Registered organizations generally include corporations, limited partnerships and limited liability companies.  Note that a general partnership is not considered a registered organization under the UCC.  “Public organic record” is a new definition that is included in the 2010 Amendments, and it means a record available to the public and consisting of the record initially filed with or issued by a state or the United States to form or organize an organization (and any publicly filed record that amends or restates the original record).

A debtor that is an unregistered organization (including a general partnership) is located in the jurisdiction of its place of business (if it has only one place of business) or of its chief executive office (if it has multiple places of business).

Note, however, that with respect to non-U.S. organizations (whether they qualify as registered organizations or not), the rules governing the location of such organizations are complex and are beyond the scope of this article.

A debtor that is an individual is located at the place of his or her principal residence.   Best practices dictate that if an individual debtor maintains residences in multiple jurisdictions and it is unclear which one is the “principal residence,” a lender should proceed under the assumption that the debtor’s location could be any of such jurisdictions.

A Word About Search Logic

Although it is beyond the scope of this article to describe in detail the various types of search logic used by different jurisdictions in connection with their UCC records, a quick overview is necessary.  UCC records are indexed and thereby searched by the applicable filing office according to the name of the debtor.  These searches are done electronically using the specific search logic adopted by the relevant jurisdiction and have little margin for error.  This means that even a minor mistake in a debtor’s name on a financing statement could cause that financing statement to be missed during a search that is conducted based on the correct debtor name.  Under the UCC, the failure to provide the correct name of the debtor on a financing statement is deemed to render the financing statement “seriously misleading” (a UCC term of art) and thus ineffective to perfect a secured party’s security interest in the collateral detailed therein.  The one exception to this rule is that if the filing office’s standard search logic actually does find a financing statement that incorrectly represents the debtor’s name, such financing statement, despite its errors, would not be deemed to be seriously misleading based on the incorrect name.  Needless to say, every effort should be made to ensure that the debtor name on a financing statement is absolutely correct so as to avoid any reliance on this narrow (and unpredictable) exception.

Debtor Names

Registered Organizations

Debtor naming conventions are most straightforward when the debtor is a registered organization.  The debtor name on the financing statement must reflect the name set forth in such organization’s public organic record most recently filed with its state of organization or incorporation. 

Prior to the enactment of the 2010 Amendments, a financing statement properly identified a business debtor “only if the financing statement provides the name of the debtor indicated on the public record [emphasis added] of the debtor’s jurisdiction of organization which shows the debtor to have been organized.”  Exactly what constitutes “on the public record” is ambiguous and open to different interpretations.  For example, prior to the enactment of the 2010 Amendments, a certificate of good standing or a published index of domestic corporations were considered by some to be reliable “public records” that reflected debtor names.  The concept of “public organic record” was added in the 2010 Amendments to eliminate this vagueness.  A public organic record is typically the certificate of formation, articles of organization, certificate of incorporation or similar charter document that is maintained in the public record in the applicable jurisdiction.

With respect to a debtor that is a registered organization, the pre-2010 Amendments financing statement form generally required the inclusion of the debtor’s type of organization, jurisdiction of organization and organizational identification number (or an indication that the debtor does not have one).  The 2010 Amendments eliminate these disclosure requirements, and the new financing statement form, which no longer has these information fields, should be used starting July 1, 2013, in jurisdictions that have adopted the 2010 Amendments.

Unregistered Organizations

The 2010 Amendments did not make any substantive changes regarding debtor naming conventions or requirements for unregistered organizations.  If the debtor is an unregistered organization that has a name, that name should be used in the financing statement.  All possible sources evidencing the debtor’s name, such as government records and filings, tax returns, etc., should be reviewed to confirm the debtor’s name; if more than one name is used, the financing statement should reflect all such names as additional debtors.  However, for an unregistered organization that does not have a name, the financing statement should include the names of all of the partners, members, associates or other persons comprising the debtor.  The naming conventions (and location rules) for these entities and persons follow the rules for registered organizations, unregistered organizations and individual debtors discussed herein.

Individual Debtors

The most significant changes made by the 2010 Amendments with respect to debtor naming relate to individual debtor names.  Under the UCC without regard to the 2010 Amendments, a financing statement would sufficiently provide the name of an individual debtor if it listed the “name of the debtor,” but the UCC provided little guidance as to what constituted the debtor’s name.  The 2010 Amendments represent an effort to provide such guidance.  Under the 2010 Amendments, two alternative approaches, commonly known as Alternative A, the “only if” approach, and Alternative B, the “safe harbor” approach, were formulated.  Of the 45 jurisdictions that had enacted the 2010 Amendments as of July 3, 2013, the vast majority, including the District of Columbia, Florida, Illinois, Massachusetts and Texas, chose Alternative A, while only a handful, including Delaware, chose Alternative B.  A chart at the end of the article shows which of the jurisdictions that have adopted the 2010 Amendments chose Alternative A and which chose Alternative B.

Alternative A – The “Only If” Approach

Alternative A, or the “only if” approach, requires the name of an individual debtor to be the name set forth on such individual’s unexpired driver’s license issued by the Department of Motor Vehicles or equivalent agency of the state where the debtor is located (the Driver’s License Name).  This requirement dictates strict compliance so that, even if there is a naming error on the driver’s license, such error should be replicated on the financing statement.  If the individual has been issued multiple driver’s licenses in the same jurisdiction, the most recently issued one controls.  A driver’s license issued by a state other than the one where the debtor is located may not be relied upon for determining the Driver’s License Name.

For example, Michael John Smith, an individual, lives in Illinois and grants a security interest to a lender, who promptly files a financing statement naming “Michael John Smith” as the debtor after verifying the name on his unexpired Illinois driver’s license.  The financing statement is still effective even if Michael’s actual name (as set forth on his birth certificate, passport, tax return or other record) is Michael Jon Smith.  If the lender filed against “Michael J. Smith” or “Michael Jon Smith,” the financing statement would only be effective under Alternative A if the Illinois search logic would, despite the variance from the Driver’s License Name, retrieve this financing statement, thereby fitting within the exception noted in the previous search logic discussion.  However, it would be ill advised to deviate in any way from the debtor’s Driver’s License Name in an Alternative A jurisdiction.  Note that financing statement forms provide separate boxes for an individual debtor’s surname, first personal name, additional names/initials and suffix.  These boxes must be completed accurately regardless of how the debtor’s name is ordered on a driver’s license.

If an individual located in an Alternative A jurisdiction does not have a driver’s license issued by that jurisdiction, or the license is expired, the financing statement must be filed against “the individual name of the debtor” or the “debtor’s surname and first personal name.”  The UCC does not define the “individual name of the debtor” or what elements constitute a debtor’s surname and first personal name, nor does it clarify the difference between the two.  However, the official comments to Section 9-503 suggest that a court interpreting the sufficiency of a debtor’s individual name should refer to any non-UCC law concerning proper name identification, keeping in mind that name interpretation in other contexts might not be applicable to a UCC-related dispute.  The official comments also suggest that a court should give effect to the directive in Section 1-103(a)(1) that the UCC “must be liberally construed and applied to promote its underlying purposes and policies.”  Best practice dictates that, when in an Alternative A jurisdiction and there is no unexpired driver’s license available from which to determine the Driver’s License Name, the secured party should include as additional debtors on its financing statement all iterations of a debtor’s name, including those reflected on any official documents that can be obtained (including expired or out-of-state driver’s licenses, birth certificate, passport and recent tax returns).

Alternative B – the “Safe Harbor” Approach

Under Alternative B, or the “safe harbor” approach, a financing statement is effective if filed against the individual debtor’s (a) Driver’s License Name (if any), (b) “individual name,” or (c) “surname and first personal name” (see previous discussion regarding issues relating to the lack of clarity in the UCC with respect to what is meant by “individual name” and “surname and first personal name”).  Unlike the regimen under Alternative A, each of these debtor-naming conventions is deemed equal under Alternative B.  Using the example above, a financing statement identifying the debtor as “Michael John Smith,” “Michael Jon Smith” or “Michael Smith” would be sufficient under Alternative B since these names represent Michael’s Driver’s License Name, his “individual name” (as reflected on the documents referred to in the example), and his “surname and first personal name,” respectively.

This article is intended to provide a broad overview of debtor-naming conventions and how they were changed by the 2010 Amendments.  Prior to filing a financing statement or conducting a search, the laws of the jurisdiction of the debtor’s location should be carefully reviewed, because they vary from state to state, and some states have not adopted the 2010 Amendments.  Additional issues arise if a debtor changes its name or its location after the filing of the original financing statement against that debtor, and it is beyond the scope of this article to address those issues.

Notes

In California, the 2010 Amendments bill is pending in the legislature and, assuming it is passed, will not become effective until July 1, 2014.  The pending bill does not contemplate changing the individual debtor-naming convention from the vague “name of the debtor” standard under the current UCC.  However, those monitoring the legislative process expect that one of the alternatives will be adopted and added to the bill before it becomes law.

A 2010-Amendments-related bill (which adopts Alternative A) has been introduced but not passed in New York.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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JD Supra Privacy Policy

Updated: May 25, 2018:

JD Supra is a legal publishing service that connects experts and their content with broader audiences of professionals, journalists and associations.

This Privacy Policy describes how JD Supra, LLC ("JD Supra" or "we," "us," or "our") collects, uses and shares personal data collected from visitors to our website (located at www.jdsupra.com) (our "Website") who view only publicly-available content as well as subscribers to our services (such as our email digests or author tools)(our "Services"). By using our Website and registering for one of our Services, you are agreeing to the terms of this Privacy Policy.

Please note that if you subscribe to one of our Services, you can make choices about how we collect, use and share your information through our Privacy Center under the "My Account" dashboard (available if you are logged into your JD Supra account).

Collection of Information

Registration Information. When you register with JD Supra for our Website and Services, either as an author or as a subscriber, you will be asked to provide identifying information to create your JD Supra account ("Registration Data"), such as your:

  • Email
  • First Name
  • Last Name
  • Company Name
  • Company Industry
  • Title
  • Country

Other Information: We also collect other information you may voluntarily provide. This may include content you provide for publication. We may also receive your communications with others through our Website and Services (such as contacting an author through our Website) or communications directly with us (such as through email, feedback or other forms or social media). If you are a subscribed user, we will also collect your user preferences, such as the types of articles you would like to read.

Information from third parties (such as, from your employer or LinkedIn): We may also receive information about you from third party sources. For example, your employer may provide your information to us, such as in connection with an article submitted by your employer for publication. If you choose to use LinkedIn to subscribe to our Website and Services, we also collect information related to your LinkedIn account and profile.

Your interactions with our Website and Services: As is true of most websites, we gather certain information automatically. This information includes IP addresses, browser type, Internet service provider (ISP), referring/exit pages, operating system, date/time stamp and clickstream data. We use this information to analyze trends, to administer the Website and our Services, to improve the content and performance of our Website and Services, and to track users' movements around the site. We may also link this automatically-collected data to personal information, for example, to inform authors about who has read their articles. Some of this data is collected through information sent by your web browser. We also use cookies and other tracking technologies to collect this information. To learn more about cookies and other tracking technologies that JD Supra may use on our Website and Services please see our "Cookies Guide" page.

How do we use this information?

We use the information and data we collect principally in order to provide our Website and Services. More specifically, we may use your personal information to:

  • Operate our Website and Services and publish content;
  • Distribute content to you in accordance with your preferences as well as to provide other notifications to you (for example, updates about our policies and terms);
  • Measure readership and usage of the Website and Services;
  • Communicate with you regarding your questions and requests;
  • Authenticate users and to provide for the safety and security of our Website and Services;
  • Conduct research and similar activities to improve our Website and Services; and
  • Comply with our legal and regulatory responsibilities and to enforce our rights.

How is your information shared?

  • Content and other public information (such as an author profile) is shared on our Website and Services, including via email digests and social media feeds, and is accessible to the general public.
  • If you choose to use our Website and Services to communicate directly with a company or individual, such communication may be shared accordingly.
  • Readership information is provided to publishing law firms and authors of content to give them insight into their readership and to help them to improve their content.
  • Our Website may offer you the opportunity to share information through our Website, such as through Facebook's "Like" or Twitter's "Tweet" button. We offer this functionality to help generate interest in our Website and content and to permit you to recommend content to your contacts. You should be aware that sharing through such functionality may result in information being collected by the applicable social media network and possibly being made publicly available (for example, through a search engine). Any such information collection would be subject to such third party social media network's privacy policy.
  • Your information may also be shared to parties who support our business, such as professional advisors as well as web-hosting providers, analytics providers and other information technology providers.
  • Any court, governmental authority, law enforcement agency or other third party where we believe disclosure is necessary to comply with a legal or regulatory obligation, or otherwise to protect our rights, the rights of any third party or individuals' personal safety, or to detect, prevent, or otherwise address fraud, security or safety issues.
  • To our affiliated entities and in connection with the sale, assignment or other transfer of our company or our business.

How We Protect Your Information

JD Supra takes reasonable and appropriate precautions to insure that user information is protected from loss, misuse and unauthorized access, disclosure, alteration and destruction. We restrict access to user information to those individuals who reasonably need access to perform their job functions, such as our third party email service, customer service personnel and technical staff. You should keep in mind that no Internet transmission is ever 100% secure or error-free. Where you use log-in credentials (usernames, passwords) on our Website, please remember that it is your responsibility to safeguard them. If you believe that your log-in credentials have been compromised, please contact us at privacy@jdsupra.com.

Children's Information

Our Website and Services are not directed at children under the age of 16 and we do not knowingly collect personal information from children under the age of 16 through our Website and/or Services. If you have reason to believe that a child under the age of 16 has provided personal information to us, please contact us, and we will endeavor to delete that information from our databases.

Links to Other Websites

Our Website and Services may contain links to other websites. The operators of such other websites may collect information about you, including through cookies or other technologies. If you are using our Website or Services and click a link to another site, you will leave our Website and this Policy will not apply to your use of and activity on those other sites. We encourage you to read the legal notices posted on those sites, including their privacy policies. We are not responsible for the data collection and use practices of such other sites. This Policy applies solely to the information collected in connection with your use of our Website and Services and does not apply to any practices conducted offline or in connection with any other websites.

Information for EU and Swiss Residents

JD Supra's principal place of business is in the United States. By subscribing to our website, you expressly consent to your information being processed in the United States.

  • Our Legal Basis for Processing: Generally, we rely on our legitimate interests in order to process your personal information. For example, we rely on this legal ground if we use your personal information to manage your Registration Data and administer our relationship with you; to deliver our Website and Services; understand and improve our Website and Services; report reader analytics to our authors; to personalize your experience on our Website and Services; and where necessary to protect or defend our or another's rights or property, or to detect, prevent, or otherwise address fraud, security, safety or privacy issues. Please see Article 6(1)(f) of the E.U. General Data Protection Regulation ("GDPR") In addition, there may be other situations where other grounds for processing may exist, such as where processing is a result of legal requirements (GDPR Article 6(1)(c)) or for reasons of public interest (GDPR Article 6(1)(e)). Please see the "Your Rights" section of this Privacy Policy immediately below for more information about how you may request that we limit or refrain from processing your personal information.
  • Your Rights
    • Right of Access/Portability: You can ask to review details about the information we hold about you and how that information has been used and disclosed. Note that we may request to verify your identification before fulfilling your request. You can also request that your personal information is provided to you in a commonly used electronic format so that you can share it with other organizations.
    • Right to Correct Information: You may ask that we make corrections to any information we hold, if you believe such correction to be necessary.
    • Right to Restrict Our Processing or Erasure of Information: You also have the right in certain circumstances to ask us to restrict processing of your personal information or to erase your personal information. Where you have consented to our use of your personal information, you can withdraw your consent at any time.

You can make a request to exercise any of these rights by emailing us at privacy@jdsupra.com or by writing to us at:

Privacy Officer
JD Supra, LLC
10 Liberty Ship Way, Suite 300
Sausalito, California 94965

You can also manage your profile and subscriptions through our Privacy Center under the "My Account" dashboard.

We will make all practical efforts to respect your wishes. There may be times, however, where we are not able to fulfill your request, for example, if applicable law prohibits our compliance. Please note that JD Supra does not use "automatic decision making" or "profiling" as those terms are defined in the GDPR.

  • Timeframe for retaining your personal information: We will retain your personal information in a form that identifies you only for as long as it serves the purpose(s) for which it was initially collected as stated in this Privacy Policy, or subsequently authorized. We may continue processing your personal information for longer periods, but only for the time and to the extent such processing reasonably serves the purposes of archiving in the public interest, journalism, literature and art, scientific or historical research and statistical analysis, and subject to the protection of this Privacy Policy. For example, if you are an author, your personal information may continue to be published in connection with your article indefinitely. When we have no ongoing legitimate business need to process your personal information, we will either delete or anonymize it, or, if this is not possible (for example, because your personal information has been stored in backup archives), then we will securely store your personal information and isolate it from any further processing until deletion is possible.
  • Onward Transfer to Third Parties: As noted in the "How We Share Your Data" Section above, JD Supra may share your information with third parties. When JD Supra discloses your personal information to third parties, we have ensured that such third parties have either certified under the EU-U.S. or Swiss Privacy Shield Framework and will process all personal data received from EU member states/Switzerland in reliance on the applicable Privacy Shield Framework or that they have been subjected to strict contractual provisions in their contract with us to guarantee an adequate level of data protection for your data.

California Privacy Rights

Pursuant to Section 1798.83 of the California Civil Code, our customers who are California residents have the right to request certain information regarding our disclosure of personal information to third parties for their direct marketing purposes.

You can make a request for this information by emailing us at privacy@jdsupra.com or by writing to us at:

Privacy Officer
JD Supra, LLC
10 Liberty Ship Way, Suite 300
Sausalito, California 94965

Some browsers have incorporated a Do Not Track (DNT) feature. These features, when turned on, send a signal that you prefer that the website you are visiting not collect and use data regarding your online searching and browsing activities. As there is not yet a common understanding on how to interpret the DNT signal, we currently do not respond to DNT signals on our site.

Access/Correct/Update/Delete Personal Information

For non-EU/Swiss residents, if you would like to know what personal information we have about you, you can send an e-mail to privacy@jdsupra.com. We will be in contact with you (by mail or otherwise) to verify your identity and provide you the information you request. We will respond within 30 days to your request for access to your personal information. In some cases, we may not be able to remove your personal information, in which case we will let you know if we are unable to do so and why. If you would like to correct or update your personal information, you can manage your profile and subscriptions through our Privacy Center under the "My Account" dashboard. If you would like to delete your account or remove your information from our Website and Services, send an e-mail to privacy@jdsupra.com.

Changes in Our Privacy Policy

We reserve the right to change this Privacy Policy at any time. Please refer to the date at the top of this page to determine when this Policy was last revised. Any changes to our Privacy Policy will become effective upon posting of the revised policy on the Website. By continuing to use our Website and Services following such changes, you will be deemed to have agreed to such changes.

Contacting JD Supra

If you have any questions about this Privacy Policy, the practices of this site, your dealings with our Website or Services, or if you would like to change any of the information you have provided to us, please contact us at: privacy@jdsupra.com.

JD Supra Cookie Guide

As with many websites, JD Supra's website (located at www.jdsupra.com) (our "Website") and our services (such as our email article digests)(our "Services") use a standard technology called a "cookie" and other similar technologies (such as, pixels and web beacons), which are small data files that are transferred to your computer when you use our Website and Services. These technologies automatically identify your browser whenever you interact with our Website and Services.

How We Use Cookies and Other Tracking Technologies

We use cookies and other tracking technologies to:

  1. Improve the user experience on our Website and Services;
  2. Store the authorization token that users receive when they login to the private areas of our Website. This token is specific to a user's login session and requires a valid username and password to obtain. It is required to access the user's profile information, subscriptions, and analytics;
  3. Track anonymous site usage; and
  4. Permit connectivity with social media networks to permit content sharing.

There are different types of cookies and other technologies used our Website, notably:

  • "Session cookies" - These cookies only last as long as your online session, and disappear from your computer or device when you close your browser (like Internet Explorer, Google Chrome or Safari).
  • "Persistent cookies" - These cookies stay on your computer or device after your browser has been closed and last for a time specified in the cookie. We use persistent cookies when we need to know who you are for more than one browsing session. For example, we use them to remember your preferences for the next time you visit.
  • "Web Beacons/Pixels" - Some of our web pages and emails may also contain small electronic images known as web beacons, clear GIFs or single-pixel GIFs. These images are placed on a web page or email and typically work in conjunction with cookies to collect data. We use these images to identify our users and user behavior, such as counting the number of users who have visited a web page or acted upon one of our email digests.

JD Supra Cookies. We place our own cookies on your computer to track certain information about you while you are using our Website and Services. For example, we place a session cookie on your computer each time you visit our Website. We use these cookies to allow you to log-in to your subscriber account. In addition, through these cookies we are able to collect information about how you use the Website, including what browser you may be using, your IP address, and the URL address you came from upon visiting our Website and the URL you next visit (even if those URLs are not on our Website). We also utilize email web beacons to monitor whether our emails are being delivered and read. We also use these tools to help deliver reader analytics to our authors to give them insight into their readership and help them to improve their content, so that it is most useful for our users.

Analytics/Performance Cookies. JD Supra also uses the following analytic tools to help us analyze the performance of our Website and Services as well as how visitors use our Website and Services:

  • HubSpot - For more information about HubSpot cookies, please visit legal.hubspot.com/privacy-policy.
  • New Relic - For more information on New Relic cookies, please visit www.newrelic.com/privacy.
  • Google Analytics - For more information on Google Analytics cookies, visit www.google.com/policies. To opt-out of being tracked by Google Analytics across all websites visit http://tools.google.com/dlpage/gaoptout. This will allow you to download and install a Google Analytics cookie-free web browser.

Facebook, Twitter and other Social Network Cookies. Our content pages allow you to share content appearing on our Website and Services to your social media accounts through the "Like," "Tweet," or similar buttons displayed on such pages. To accomplish this Service, we embed code that such third party social networks provide and that we do not control. These buttons know that you are logged in to your social network account and therefore such social networks could also know that you are viewing the JD Supra Website.

Controlling and Deleting Cookies

If you would like to change how a browser uses cookies, including blocking or deleting cookies from the JD Supra Website and Services you can do so by changing the settings in your web browser. To control cookies, most browsers allow you to either accept or reject all cookies, only accept certain types of cookies, or prompt you every time a site wishes to save a cookie. It's also easy to delete cookies that are already saved on your device by a browser.

The processes for controlling and deleting cookies vary depending on which browser you use. To find out how to do so with a particular browser, you can use your browser's "Help" function or alternatively, you can visit http://www.aboutcookies.org which explains, step-by-step, how to control and delete cookies in most browsers.

Updates to This Policy

We may update this cookie policy and our Privacy Policy from time-to-time, particularly as technology changes. You can always check this page for the latest version. We may also notify you of changes to our privacy policy by email.

Contacting JD Supra

If you have any questions about how we use cookies and other tracking technologies, please contact us at: privacy@jdsupra.com.

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