REVISED ARTICLE 9

A revised version of Article 9 (“new Article 9”; the prior version to be referred to as “prior Article 9”) of the Uniform Commercial Code was adopted in all 50 states and became effective on July 1, 2001. The revision contains many significant changes to existing law, in some places clarifying hotly debated points, and in others making wholesale changes that will require security interest holders to take action to maintain perfection of their secured interests. Below is a bullet point summary of some of the key provisions of the revised article, followed by a more detailed discussion of each item.

Expanded Definition of Collateral Covered by New Article 9

• Additional classes of securities governed by new Article 9.
• Many rights to payment previously called “Accounts” now classified as general intangibles and require financing statement.
• Possession trumps filing, even earlier filing.

Changes to Rules Regarding Filing of Financing Statements

• Financing statement must be filed in State of debtor.
• Debtor’s name must be exact on financing statement.
• Creditor required to re-file on change of debtor’s name or State.

Transition Rules

• One year grace period to correct filings made imperfect by new rules.
• Procedures for re-perfecting.

EXPANDED DEFINITION OF COLLATERAL UNDER ARTICLE 9

Additional Classes of Securities
New Article 9 significantly expands the scope of covered collateral as compared to prior Article 9. Now included as collateral, and therefore subject to Article 9’s rules governing perfection of security interests, are categories such as “Commercial Tort Claims”, “Health-Care Insurance Receivables”, “Software” and “Letter of Credit Rights”, as well as subcategories including “Payment Intangibles” as a type of general intangibles and “Promissory Notes” as a type of instruments.

Accounts
In addition, changes have been made to the definition of “Accounts” under Article 9 such that many “rights to payment” previously classified as general intangibles are now considered “Accounts”, and therefore require the filing of a financing statement in order to perfect a secured interest. The net effect of these changes is that a much broader range of property may be collateralized as security by filing a UCC-1 financing statement as opposed to physical possession of the collateral document or instrument.

Priority of Claims: Filing vs. Possession
New Article 9 also resolves a few questions that were not entirely clear under the old rules, and which had become the subject of some debate by courts. Among the changes, new Article 9 retained rules affecting the priorities of multiple secured creditors, while updating them to reflect electronic transactions. Under Article 9 in both pre-and post-revised forms, a secured creditor who relies on the filing of a financing statement alone will lose priority to another creditor who becomes secured subsequently and takes possession of the collateral debt instrument or obtains control over investment property (or “electronic chattel paper” under new Article 9). “Control” in this case refers to the ability to direct investment of investment property, unique “markings” on electronic chattel papers that indicate the secured creditor’s control over such papers, or the consent of the issuer of letters of credit to an assigment of the proceeds thereof to the secured creditor.

NEW FILING RULES

Article 9 was revised in part to reflect the increasingly electronic form of many transactions. For example, the revision no longer refers to a need for signatures on documents, instead referring to “authentication” of “records”. Similarly, new Article 9 no longer requires that the debtor sign a financing statement, a move designed to faciliate the electronic filing of financing statements, although California has not yet implemented procedures for electronic filing of financing statements.

Filing Only in “Location” of Debtor
Prior Article 9 required that a financing statement be filed with the Secretary of State of the State in which collateral was held. Furthermore, at least one case has held that in order to perfect a security interest in a U.S. patent, the financing statement must be filed with the U.S. Patent Office. Thus, under prior law, for a business holding assets in several states, financing statements could be on file in more than one location, making more difficult the task of determining the existence and relative priorities of all secured interests. Article 9 simplifies procedures by requiring that all financing statements be filed in the “location” of the debtor. For entities organized by filing with the Secretary of State such as corporations and LLCs, “location” means the Secretary of State in the entity’s State of organization. For other businesses, “location” means the chief executive office, and for individuals it refers to the principal residence. The effect of this revision is to provide a single place in which all financing statements relating to a person or an entity must be filed. This greatly simplifies the job of locating all financing statements and determing relative temporal priorities.

Exact Name of Debtor
Another step taken for the purpose of simplifying financing statement searches is the provision of a statutory standard for conducting debtor name searches. Under the new rules, the legal name of the person or entity must be used, and a computerized search performed by the Secretary of State must bring up the debtor’s name. In other words, there is no “close enough”; a search will either show the debtor’s name or it will not, and a security interest will be deemed unperfected if the debtor’s name does not appear. Variations in the search terms used, uniqueness of the debtor name and the particular workings of the software performing the search may cause this rule to be more or less flexible, but the implication is clear that it is vital to the creditor to get the debtor name precisely right prior to filing.

Ongoing Vigilance Required
One important consequence of these new rules is that creditors must be certain not only that the name and location of the debtor are correct on the financing statement at the time of filing, but that they remain correct at all times while the financing statement remains effective. If the debtor changes its name or state of incorporation, the financing statement will not automatically “follow” the debtor. The financing statement must be amended or refiled to reflect any location change or name change that could result in a failure of a computer search to find the financing statement. Creditors should remain in close contact with debtors in order to obtain sufficient notice of any changes that might cause the security interest to become unperfected.

TRANSITION RULES

One Year Grace Period
One important question facing creditors is “will the security interest I perfected under the old rules remain perfected under the new rules?” The short answer to this question is that security interests will remain perfected only if perfected under the new rules. If perfection under prior Article 9 would satisfy rules for perfection under new Article 9, then no further action is required. On the other hand, interests perfected under prior Article 9 that do not conform to Article 9’s revised requirements will remain perfected for only one year following adoption of the revised Article. Action by the secured party will be required to amend or update the financing statement to maintain a perfected security interest. The following chart breaks down the various permutations:

• Interests perfected under pre-revision rules that would also be perfected under new Article 9 shall continue perfected with no action required;
• Interests perfected under pre-revision rules by filing that would not be perfected under new Article 9, shall remain perfected until June 30, 2006 (or the earlier lapse of the financing statement);
• Interests perfected under pre-revision rules without filing that would not be perfected under new Article 9, shall remain perfected for 1 year following adoption of new Article 9, or until June 30, 2002 (note that this time period has now expired);
• Security interest that are not perfected under new Article 9 within the applicable time period shall be considered unperfected.

Note that creditors whose security interests attached after adoption of new Article 9, and where the interest was perfected under pre-revision rules, are also given the one year grace period to update or correct the filing in order to perfect under new Article 9.

Re-Perfecting Interests Secured under old Rules
There are two ways to re-perfect a security interest previously perfected under prior Article 9. If the location of the original filing would be correct under new Article 9, a “continuation statement” may be filed containing any amended or additional information needed to perfect under the revised Article. On the other hand, if new Article 9 would require filing in a different state, then an “in lieu” financing statement must be filed with the appropriate Secretary of State. The “in lieu” statement must identify the original filing by filing office, date of filing and filing number, and must indicate that the original filing remains effective in order to “continue” the priority of the original filing.

Finally, new Article 9 governs priority of security interests that were not established prior to adoption of the revised Article. Thus, the relative priorities of security interests attached and perfected prior to the adoption of new Article 9 will continue to be governed by pre-revision rules.

GENERAL INFORMATION

The above discussion merely highlights some of the most salient points of new Article 9. The revision makes numerous additional changes to prior law, and readers are advised to consult with an attorney prior to taking any action. For more information, please contact one of the attorneys in our transactions group: Gerald V. Niewsar (gniesar@nvlawllp.com), Oscar E. Escobar (oescobar@nvlawllp.com).