New UCC Legislation: The Creation of a Substantial Debtor Name Due Diligence Burden

The sufficiency of individual debtor names has been an ongoing concern for secured parties since Revised Article 9 took effect in 2001. Accurate debtor names
are essential for smooth operation of the secured transactions process. Financing statements are indexed and searched by debtor name. Any errors or omissions in a debtor name could prevent a search from disclosing the UCC record, resulting in a hidden lien.

To minimize the risk of hidden liens, Article 9 requires the secured party to provide the correct name of the debtor as specified in UCC '9-503(a). If a financing statement fails to correctly provide the name of the debtor, it is seriously misleading and ineffective under '9-506(b). There is a narrow exception under '9-506(c) where a noncompliant debtor name does not make the financing statement seriously misleading if a search of the debtor's correct name, using the jurisdiction's standard search logic, would disclose the record.

While '9-503(a) provides specific rules for the sufficiency of some of debtor name types, such as registered organizations, it is utterly silent as to what constitutes the correct name of an individual. Under '9-503(a)(4)(A), a financing statement sufficiently provides the name of an individual debtor ' ' only if it provides the individual … name of the debtor.' The statutory language simply provides no standard to help lenders determine an individual's correct name.

Determining the 'correct' name of an individual can be a difficult task in many cases. At common law, a person can lawfully choose any name he or she desires, provided it is not for a deceptive or fraudulent purpose. A name can be established through usage or habit without the need for legal proceedings that leave an official record. The situation gets even more complicated when the name involves hyphenation or follows foreign naming conventions. A secured party can do little more than exercise its best judgment to determine the correct name of an individual and hope that the courts later agree with the decision.

The lack of any individual name certainty creates an unacceptable risk for some lenders. Lenders often enter into significant financial transactions with individual debtors. Individuals run sole proprietorships, engage in farming operations, and act as personal guarantors for businesses. It is critical that secured lenders have a reasonable level of confidence that they can get the name right.

The First Solution

In response to concerns over the individual debtor name issue, Texas became the first state to offer a legislative solution. Texas Senate Bill 1540 carved out an individual name safe harbor in '9-503(a) if the financing statement provided the name of the debtor indicated on the individual's driver's license or state-issued identification certificate. The law took effect on June 16, 2007.

The State Bar of Texas UCC Committee initially drafted Senate Bill 1540 and was the bill's chief proponent. The UCC Committee carefully researched the issue and proposed a safe harbor based on the name provided on an individual's driver's license. The Texas Department of Public Safety has clear application requirements for names on driver's licenses or identification certificates (see 37 Tex. Admin. Code '15.23 (1999)). The drafters were confident that the Driver's License Rules created a clear standard for establishing an individual's name and were consistent with common identification practices. After all, a driver's license is almost universally accepted as the primary form of identification in the United States.

Before submitting its proposal for consideration by the legislature, the UCC Committee sought the input of various stakeholders to identify any drafting weaknesses. Representatives of the Texas Secretary of State's office, Independent Bankers Assoc- iation of Texas, and UCC service industry all had a chance to review and comment on the draft.

The Texas initiative resulted in the first individual name safe harbor. Secured parties now have some certainty that an individual debtor name will be sufficient for the financing statement to perfect the security interest. Moreover, the law did not create an additional due diligence burden for prospective lenders. Best due diligence practices already required a lender to conduct UCC searches on the driver's license name in addition to other individual names that could also be correct under Article 9.

The Tennessee Legislation

In 2008, the Tennessee legislature introduced a bill that substantially copied the Texas legislation. Senate Bill 3732 amended Tennessee's version of UCC '9-503(a) with the stated purpose of creating a broad safe harbor for individual debtor names. On March 25, 2008 Gov. Phil Bredesen signed Senate Bill 3732. The bill has an effective date of May 1, 2008.

The new law imposes a significant new due diligence burden on prospective lenders when the borrower is an individual. The amended version of Tenn. Code Ann. '47-9-503 provides a much broader safe harbor than for just the name on the driver's license. The Tennessee amendment provides that an individual debtor name is sufficient if the financing statement provides the individual's name shown on one the following 'safe harbor' documents: the debtor's driver's license, state-issued identification card, birth certificate, passport, Social Security card, or military identification card.

The bill did accomplish the goal of creating a broad safe harbor, but it neglected to take into account the impact on prospective lenders. In some cases, these 'safe harbor documents' may reflect up to five different name variations. The new law effectively requires a prospective lender to request all of these documents from the debtor and conduct searches on every name listed on the different documents.

The best due diligence practice for individual debtors in Tennessee now requires the lender to go through a checklist of safe harbor documents with the prospective borrower. The lender must then conduct a UCC search on every name variation disclosed by those documents. The names on each document could differ, but all are sufficient under this safe harbor. The due diligence process will be more costly for the lender, but it is necessary to manage the added risks imposed by the new law.

The Nebraska Legislation

On March 19, 2008, Nebraska Gov. Dave Heineman signed LB 851. A provision buried deep in the bill amended Article 9 to protect UCC filers from insufficient individual debtor names. The new law will take effect three calendar months following adjournment of the legislative session, which was scheduled for mid-April. The changes will have a substantial effect on due diligence practices, so lenders must be prepared to adjust their procedures prior to July 2008.

While Texas and Tennessee focused on creating a safe harbor, Nebraska took an entirely different approach to the individual debtor name problem. Instead of a safe harbor, the Nebraska bill expanded the savings provision in '9-506(c). The new Nebraska version of '9-506(c) now states:

If a search of the records of the filing office under the debtor's correct name, or, in the case of a debtor who is an individual, the debtor's correct last name, using the filing office's standard search logic, if any, would disclose a financing statement that fails sufficiently to provide the name of the debtor in accordance with section 9-503(a), the name provided does not make the financing statement seriously misleading.

The intent of this amendment was to provide secured parties with greater certainty that errors or omissions in an individual debtor's first or middle name would not make a financing statement seriously misleading. The bill sailed through the legislative process without opposition. The Nebraska Banker's Association was the chief proponent of the bill. The Nebraska Secretary of State took a neutral position on the legislation, while the Nebraska State Bar Assoc- iation was silent on the matter.

The lack of any critical opposition to LB 851 allowed a serious flaw to slip through. The amended version of '9-506(c) unintentionally imposes an extraordinary due diligence burden on prospective lenders. By the plain language of the bill, a financing statement is not seriously misleading if it merely provides the individual debtor's correct last name. The first and middle names are irrelevant for purposes of perfection. Consequently, a prospective lender can no longer safely limit a due diligence UCC search to financing statements that match the debtor's first and last names. When LB 851 takes effect, a diligent lender must review every financing statement disclosed on a search of just the debtor's last name.

Lenders have the ability to search exclusively by an individual's last name using the Nebraska Secretary of State UCC search system. A search by last name alone can disclose a huge number of financing statements when the debtor has a common name. The result is that lenders face increased copy costs and must spend additional time to review all the records.

A recent search of the Nebraska Secretary of State's UCC index identified 2,671 active financing statements that provide the last name of 'Johnson.' All those records are potentially effective against any debtor with the same last name. For example, a prospective lender to 'Robert Johnson' must review each of the records to identify those that are effective against the borrower.

To make matters worse, there's no guarantee that a lender can find all effective records based on the debtor's first name. UCC filers no longer have any incentive to provide the individual debtor's correct first and middle names. If the last name is correct, other parts of the individual name can include initials, nicknames, or typos without any adverse consequence for the secured party. Prospective lenders bear all the risk of identifying the effective records through a UCC search. Without the ability to screen by any type of first or middle name, a prospective lender simply may not be able to identify all the effective records, even after a careful review of all financing statements that match the last name.

Borrowers may wind up paying the price for this new legislation. At least one national equipment lender is considering whether to stop doing business with individuals in Nebraska unless it can obtain a purchase money security interest. Even when credit is available, individual borrowers may face higher fees and an extended loan process.

Starting in July 2008, the best due diligence practice in Nebraska is to conduct all UCC searches on individuals exclusively by last name. Lenders will find this both costly and time consuming, but it is the only method to ensure that the search discloses all the effective records.

The Outlook

The National Conference of Comm- issioners on Uniform State Laws ('NCCUSL') and American Law Institute ('ALI'), the organizations responsible for drafting and offering official commentary on the UCC, have appointed a joint study committee to explore the individual name problem, along with other unresolved Article 9 issues. The hope is that NCCUSL/ALI will be able to offer a uniform legislative solution for the states to adopt.

A national uniform secured transactions process benefits all secured parties. However, it could take years for NCCUSL/ALI to draft acceptable uniform legislation. In the meantime, there is a risk that states will lose patience and enact further non-uniform legislation to address the individual name problem.

Paul Hodnefield is Associate General Counsel for Corporation Service Company and Co-Chair of the ABA Joint Task Force on Filing Office Operations and Search Logic. He is a frequent speaker on Article 9 perfection and priority issues. He can be contacted at 800-927-9801, ext. 2375, or [email protected].

Two states recently enacted non-uniform amendments to UCC Article 9 that should be of urgent concern to the equipment leasing and finance industry. Legislation in both Tennessee and Nebraska extends added protection to UCC filers from the risk created by uncertainty over sufficiency of individual debtor names. A secured party must provide the correct name of the debtor when filing to perfect a security interest. Yet, Article 9 offers no guidance to help a secured party determine the correct name of an individual.

Unfortunately, the new protection for UCC filers really just shifts the risk of debtor name variations to prospective lenders. As a result, lenders must exercise a heightened level of due diligence before entering into transactions with individuals in these states. This article discusses the individual debtor name problem, explains the effect of this legislation, and recommends due diligence best practices for lenders dealing with individuals located in Tennessee and Nebraska.

The Individual Debtor Name Dilemma

The sufficiency of individual debtor names has been an ongoing concern for secured parties since Revised Article 9 took effect in 2001. Accurate debtor names
are essential for smooth operation of the secured transactions process. Financing statements are indexed and searched by debtor name. Any errors or omissions in a debtor name could prevent a search from disclosing the UCC record, resulting in a hidden lien.

To minimize the risk of hidden liens, Article 9 requires the secured party to provide the correct name of the debtor as specified in UCC '9-503(a). If a financing statement fails to correctly provide the name of the debtor, it is seriously misleading and ineffective under '9-506(b). There is a narrow exception under '9-506(c) where a noncompliant debtor name does not make the financing statement seriously misleading if a search of the debtor's correct name, using the jurisdiction's standard search logic, would disclose the record.

While '9-503(a) provides specific rules for the sufficiency of some of debtor name types, such as registered organizations, it is utterly silent as to what constitutes the correct name of an individual. Under '9-503(a)(4)(A), a financing statement sufficiently provides the name of an individual debtor ' ' only if it provides the individual … name of the debtor.' The statutory language simply provides no standard to help lenders determine an individual's correct name.

Determining the 'correct' name of an individual can be a difficult task in many cases. At common law, a person can lawfully choose any name he or she desires, provided it is not for a deceptive or fraudulent purpose. A name can be established through usage or habit without the need for legal proceedings that leave an official record. The situation gets even more complicated when the name involves hyphenation or follows foreign naming conventions. A secured party can do little more than exercise its best judgment to determine the correct name of an individual and hope that the courts later agree with the decision.

The lack of any individual name certainty creates an unacceptable risk for some lenders. Lenders often enter into significant financial transactions with individual debtors. Individuals run sole proprietorships, engage in farming operations, and act as personal guarantors for businesses. It is critical that secured lenders have a reasonable level of confidence that they can get the name right.

The First Solution

In response to concerns over the individual debtor name issue, Texas became the first state to offer a legislative solution. Texas Senate Bill 1540 carved out an individual name safe harbor in '9-503(a) if the financing statement provided the name of the debtor indicated on the individual's driver's license or state-issued identification certificate. The law took effect on June 16, 2007.

The State Bar of Texas UCC Committee initially drafted Senate Bill 1540 and was the bill's chief proponent. The UCC Committee carefully researched the issue and proposed a safe harbor based on the name provided on an individual's driver's license. The Texas Department of Public Safety has clear application requirements for names on driver's licenses or identification certificates (see 37 Tex. Admin. Code '15.23 (1999)). The drafters were confident that the Driver's License Rules created a clear standard for establishing an individual's name and were consistent with common identification practices. After all, a driver's license is almost universally accepted as the primary form of identification in the United States.

Before submitting its proposal for consideration by the legislature, the UCC Committee sought the input of various stakeholders to identify any drafting weaknesses. Representatives of the Texas Secretary of State's office, Independent Bankers Assoc- iation of Texas, and UCC service industry all had a chance to review and comment on the draft.

The Texas initiative resulted in the first individual name safe harbor. Secured parties now have some certainty that an individual debtor name will be sufficient for the financing statement to perfect the security interest. Moreover, the law did not create an additional due diligence burden for prospective lenders. Best due diligence practices already required a lender to conduct UCC searches on the driver's license name in addition to other individual names that could also be correct under Article 9.

The Tennessee Legislation

In 2008, the Tennessee legislature introduced a bill that substantially copied the Texas legislation. Senate Bill 3732 amended Tennessee's version of UCC '9-503(a) with the stated purpose of creating a broad safe harbor for individual debtor names. On March 25, 2008 Gov. Phil Bredesen signed Senate Bill 3732. The bill has an effective date of May 1, 2008.

The new law imposes a significant new due diligence burden on prospective lenders when the borrower is an individual. The amended version of Tenn. Code Ann. '47-9-503 provides a much broader safe harbor than for just the name on the driver's license. The Tennessee amendment provides that an individual debtor name is sufficient if the financing statement provides the individual's name shown on one the following 'safe harbor' documents: the debtor's driver's license, state-issued identification card, birth certificate, passport, Social Security card, or military identification card.

The bill did accomplish the goal of creating a broad safe harbor, but it neglected to take into account the impact on prospective lenders. In some cases, these 'safe harbor documents' may reflect up to five different name variations. The new law effectively requires a prospective lender to request all of these documents from the debtor and conduct searches on every name listed on the different documents.

The best due diligence practice for individual debtors in Tennessee now requires the lender to go through a checklist of safe harbor documents with the prospective borrower. The lender must then conduct a UCC search on every name variation disclosed by those documents. The names on each document could differ, but all are sufficient under this safe harbor. The due diligence process will be more costly for the lender, but it is necessary to manage the added risks imposed by the new law.

The Nebraska Legislation

On March 19, 2008, Nebraska Gov. Dave Heineman signed LB 851. A provision buried deep in the bill amended Article 9 to protect UCC filers from insufficient individual debtor names. The new law will take effect three calendar months following adjournment of the legislative session, which was scheduled for mid-April. The changes will have a substantial effect on due diligence practices, so lenders must be prepared to adjust their procedures prior to July 2008.

While Texas and Tennessee focused on creating a safe harbor, Nebraska took an entirely different approach to the individual debtor name problem. Instead of a safe harbor, the Nebraska bill expanded the savings provision in '9-506(c). The new Nebraska version of '9-506(c) now states:

If a search of the records of the filing office under the debtor's correct name, or, in the case of a debtor who is an individual, the debtor's correct last name, using the filing office's standard search logic, if any, would disclose a financing statement that fails sufficiently to provide the name of the debtor in accordance with section 9-503(a), the name provided does not make the financing statement seriously misleading.

The intent of this amendment was to provide secured parties with greater certainty that errors or omissions in an individual debtor's first or middle name would not make a financing statement seriously misleading. The bill sailed through the legislative process without opposition. The Nebraska Banker's Association was the chief proponent of the bill. The Nebraska Secretary of State took a neutral position on the legislation, while the Nebraska State Bar Assoc- iation was silent on the matter.

The lack of any critical opposition to LB 851 allowed a serious flaw to slip through. The amended version of '9-506(c) unintentionally imposes an extraordinary due diligence burden on prospective lenders. By the plain language of the bill, a financing statement is not seriously misleading if it merely provides the individual debtor's correct last name. The first and middle names are irrelevant for purposes of perfection. Consequently, a prospective lender can no longer safely limit a due diligence UCC search to financing statements that match the debtor's first and last names. When LB 851 takes effect, a diligent lender must review every financing statement disclosed on a search of just the debtor's last name.

Lenders have the ability to search exclusively by an individual's last name using the Nebraska Secretary of State UCC search system. A search by last name alone can disclose a huge number of financing statements when the debtor has a common name. The result is that lenders face increased copy costs and must spend additional time to review all the records.

A recent search of the Nebraska Secretary of State's UCC index identified 2,671 active financing statements that provide the last name of 'Johnson.' All those records are potentially effective against any debtor with the same last name. For example, a prospective lender to 'Robert Johnson' must review each of the records to identify those that are effective against the borrower.

To make matters worse, there's no guarantee that a lender can find all effective records based on the debtor's first name. UCC filers no longer have any incentive to provide the individual debtor's correct first and middle names. If the last name is correct, other parts of the individual name can include initials, nicknames, or typos without any adverse consequence for the secured party. Prospective lenders bear all the risk of identifying the effective records through a UCC search. Without the ability to screen by any type of first or middle name, a prospective lender simply may not be able to identify all the effective records, even after a careful review of all financing statements that match the last name.

Borrowers may wind up paying the price for this new legislation. At least one national equipment lender is considering whether to stop doing business with individuals in Nebraska unless it can obtain a purchase money security interest. Even when credit is available, individual borrowers may face higher fees and an extended loan process.

Starting in July 2008, the best due diligence practice in Nebraska is to conduct all UCC searches on individuals exclusively by last name. Lenders will find this both costly and time consuming, but it is the only method to ensure that the search discloses all the effective records.

The Outlook

The National Conference of Comm- issioners on Uniform State Laws ('NCCUSL') and American Law Institute ('ALI'), the organizations responsible for drafting and offering official commentary on the UCC, have appointed a joint study committee to explore the individual name problem, along with other unresolved Article 9 issues. The hope is that NCCUSL/ALI will be able to offer a uniform legislative solution for the states to adopt.

A national uniform secured transactions process benefits all secured parties. However, it could take years for NCCUSL/ALI to draft acceptable uniform legislation. In the meantime, there is a risk that states will lose patience and enact further non-uniform legislation to address the individual name problem.

Paul Hodnefield is Associate General Counsel for Corporation Service Company and Co-Chair of the ABA Joint Task Force on Filing Office Operations and Search Logic. He is a frequent speaker on Article 9 perfection and priority issues. He can be contacted at 800-927-9801, ext. 2375, or [email protected].