First Modifications Since 2001 Considered for UCC Article 9

Part Two of a Two-Part Article

Forms

Section 9-521 sets forth forms of initial financing statements and amendments. The use of these forms is not mandatory; Section 9-521's purpose is merely to provide “safe harbor” forms that are accepted in all jurisdictions. IACA has recommended several revisions to these forms. To accommodate such changes and future modifications, IACA has proposed deleting Section 9-521 (thus eliminating the forms from the statute itself) and instead delegating authority to IACA to update designated forms from time to time. IACA contends that this would improve flexibility and lead to the use of improved forms, but some state constitutions might not allow such a delegation to IACA. The authority to approve forms would thus have to rest with the secretary of state in those jurisdictions. Furthermore, although in practice the secretaries of state work closely with IACA, the proposal creates the likelihood of different forms being used in different states, a result that would promote non-uniformity and mark a return to pre-2001 practice.

Another issue is that the safe harbor forms currently contain a field for an individual debtor's Social Security number, although the filing offices in most states do not require this information. Because filing offices are under significant pressure to preserve the privacy of Social Security numbers, some states have already eliminated Section 9-521's safe harbor statutory forms and delegated approval of forms to the actual filing offices. (See, e.g., State of Kansas Senate Bill 449. Enacted on April 24, 2008; State of Alaska House Bill 295. Enacted on June 6, 2008; ch 76 SLA 08.) To ensure that more states do not eliminate the forms' safe harbor, the JRC will consider whether Section 9-521 should at least be amended to eliminate the Social Security number field.

Correction Statements

Section 9-518 enables debtors to file a “correction statement” to remedy bogus filings against them. Specifically, this provision allows the debtor to claim that a financing statement has been wrongfully or inaccurately filed. Correction statements are for informational purposes only, however, and do not render the financing statements ineffective. IACA has proposed amending Article 9 to allow correction statements to be filed by secured parties or anyone else who was entitled to file the initial financing statement, as well as the debtor. The review committee, however, has noted that because bogus financing statements would in any case not be effective under other provisions of Article 9, (See, e.g., UCC '9-203(b)) and correction statements thus have no legal effect, another option would be to delete Section 9-518 entirely. (Review committee, supra at 4-5). Nevertheless, even though correction statements have no legal effect, the information they provide often is useful to searchers. The JRC will therefore have to consider whether eliminating correction statements completely would be beneficial.

Control of Deposit Accounts

Primarily due to a non-uniform Delaware amendment, the JRC will consider whether the methods of obtaining “control” over deposit accounts should be expanded. Under Section 9-104, a secured party has control of a deposit account if: 1) the secured party is the bank with which the account is maintained, 2) the debtor, secured party and bank have agreed in an authenticated record that the bank will comply with instructions originated by the secured party directing disposition of the funds in the account without further consent by the debtor, or 3) the secured party becomes the bank's customer with respect to the account. Delaware's non-uniform Section 9-104(a)(4) enables control to be obtained where the debtor, secured party and bank have authenticated a record that: 1) is conspicuously denominated a control agreement, 2) identifies the specific deposit account in which the secured party claims a security interest, and 3) contains one or more provisions addressing the disposition of funds in the deposit account or the right to direct the disposition of funds therein. A non-uniform Section 9-104(a)(5) further provides that control is achieved where the name on the deposit account is the secured party's name or indicates that the secured party has an interest in the account even though it has not become the bank's customer. Moreover, Delaware has adopted analogous non-uniform provisions in Section 8-106(d) for controlling securities entitlements.

The review committee does not seem convinced that changes in line with those made in Delaware are justified (Review committee, supra at 6), but the JRC will continue to consider the issue.

Intangibles

Under Section 9-309(1), purchase money security interests in consumer goods are perfected automatically upon attachment. (Note that for motor vehicle liens, the security interest in the primary collateral is perfected under state certificate-of-title statutes. Section 9-309(1) applies to all other consumer goods.) Transactions involving consumer goods, however, often also include extensions of credit for intangibles, such as warranties, maintenance services and insurance, that are not included under the definition of “consumer goods.” Liens on such intangibles neither enjoy purchase money status nor benefit from Section 9-309(1)'s automatic perfection provisions. Consequently, the question has arisen as to whether automatic perfection should be extended to include such intangible collateral when it is purchased in conjunction with traditional consumer goods. The Review Committee noted that such an expansion would reflect a policy change that would need to be justified, but left this issue to consideration by the JRC. (Review committee, supra at 9.)

Commercial Money Center

The In re Commercial Money Center, 350 B.R. 465 (B.A.P. 9th Cir. 2006) decision has provoked significant discussion among commentators. (For further discussion of Commercial Money Center, see A. Christenfeld & S. Melzer, “Securitization of Payments Under Equipment Leases” 238 NYLJ, No. 67 at 5 (Oct. 4, 2007). There, a bankruptcy appellate panel stated that a right to payment on chattel paper when “stripped” from the underlying chattel paper and assigned separately becomes a “payment intangible.” This characterization is important because sales of payment intangibles are perfected automatically under Section 9-309 whereas sales of chattel paper can be perfected only by taking possession or control of the chattel paper, or by filing. Because automatic perfection creates a hidden lien that cannot be discovered with reasonable diligence, chattel paper financiers or buyers cannot be sure whether the payment streams arising from the chattel paper have previously been sold. Moreover, it is unclear whether the super-priority rules of Section 9-330 benefitting good faith purchasers of chattel paper who take possession or control would defeat the automatic perfection priority status of holders of the stripped out payment rights.

The concerns raised by Commercial Money Center could be addressed several ways. The case's holding could be rejected altogether, for example, simply by revising Article 9 to make clear that payment rights stripped from chattel paper are not payment intangibles. Alternatively, the JRC might recommend that stripped rights to payment be treated as payment intangibles but that the official comments be modified to reduce confusion over the priority concerns and other problems generated by Commercial Money Center. In any event, it is important that any recommendations from the JRC address fully the issues resulting from this decision.

Highland Capital

Another case generating confusion is Highland Capital Management v. Schneider, 8 NY 3d 406, 866 N.E.2d 1020 (2007). There, the New York Court of Appeals held that promissory notes that were part of a class or series constituted “securities” under Article 8. The court reasoned that because the promissory notes were represented by certificates, their transfer could be recorded in transfer books by the issuer as required by Section 8-102(a)(15)(i). The promissory notes thus met the definition of securities under Article 8 whether or not such records were actually maintained. Although the decision affects primarily Article 8, it has created uncertainty under Article 9 as to the proper characterization of ' and, in turn, the proper method to perfect liens upon ' certain promissory notes and uncertificated certificates of deposit. The JRC will therefore consider whether the definitions of “promissory note” and “security” should be modified so that promissory notes issued as part of a class or series are not deemed securities under Article 9.

Conclusion

Revised Article 9 generally is working well, but the experience of the past seven years has shown that certain provisions could use refinement. The issues addressed above represent just some of the key areas where changes will be considered and might be implemented in the future. Practitioners may wish to familiarize themselves with the JRC's activities and recommendations as they unfold.

This article originally appeared in the New York Law Journal, a sister publication of this newsletter.

Part Two of a Two-Part Article

Forms

Section 9-521 sets forth forms of initial financing statements and amendments. The use of these forms is not mandatory; Section 9-521's purpose is merely to provide “safe harbor” forms that are accepted in all jurisdictions. IACA has recommended several revisions to these forms. To accommodate such changes and future modifications, IACA has proposed deleting Section 9-521 (thus eliminating the forms from the statute itself) and instead delegating authority to IACA to update designated forms from time to time. IACA contends that this would improve flexibility and lead to the use of improved forms, but some state constitutions might not allow such a delegation to IACA. The authority to approve forms would thus have to rest with the secretary of state in those jurisdictions. Furthermore, although in practice the secretaries of state work closely with IACA, the proposal creates the likelihood of different forms being used in different states, a result that would promote non-uniformity and mark a return to pre-2001 practice.

Another issue is that the safe harbor forms currently contain a field for an individual debtor's Social Security number, although the filing offices in most states do not require this information. Because filing offices are under significant pressure to preserve the privacy of Social Security numbers, some states have already eliminated Section 9-521's safe harbor statutory forms and delegated approval of forms to the actual filing offices. (See, e.g., State of Kansas Senate Bill 449. Enacted on April 24, 2008; State of Alaska House Bill 295. Enacted on June 6, 2008; ch 76 SLA 08.) To ensure that more states do not eliminate the forms' safe harbor, the JRC will consider whether Section 9-521 should at least be amended to eliminate the Social Security number field.

Correction Statements

Section 9-518 enables debtors to file a “correction statement” to remedy bogus filings against them. Specifically, this provision allows the debtor to claim that a financing statement has been wrongfully or inaccurately filed. Correction statements are for informational purposes only, however, and do not render the financing statements ineffective. IACA has proposed amending Article 9 to allow correction statements to be filed by secured parties or anyone else who was entitled to file the initial financing statement, as well as the debtor. The review committee, however, has noted that because bogus financing statements would in any case not be effective under other provisions of Article 9, (See, e.g., UCC '9-203(b)) and correction statements thus have no legal effect, another option would be to delete Section 9-518 entirely. (Review committee, supra at 4-5). Nevertheless, even though correction statements have no legal effect, the information they provide often is useful to searchers. The JRC will therefore have to consider whether eliminating correction statements completely would be beneficial.

Control of Deposit Accounts

Primarily due to a non-uniform Delaware amendment, the JRC will consider whether the methods of obtaining “control” over deposit accounts should be expanded. Under Section 9-104, a secured party has control of a deposit account if: 1) the secured party is the bank with which the account is maintained, 2) the debtor, secured party and bank have agreed in an authenticated record that the bank will comply with instructions originated by the secured party directing disposition of the funds in the account without further consent by the debtor, or 3) the secured party becomes the bank's customer with respect to the account. Delaware's non-uniform Section 9-104(a)(4) enables control to be obtained where the debtor, secured party and bank have authenticated a record that: 1) is conspicuously denominated a control agreement, 2) identifies the specific deposit account in which the secured party claims a security interest, and 3) contains one or more provisions addressing the disposition of funds in the deposit account or the right to direct the disposition of funds therein. A non-uniform Section 9-104(a)(5) further provides that control is achieved where the name on the deposit account is the secured party's name or indicates that the secured party has an interest in the account even though it has not become the bank's customer. Moreover, Delaware has adopted analogous non-uniform provisions in Section 8-106(d) for controlling securities entitlements.

The review committee does not seem convinced that changes in line with those made in Delaware are justified (Review committee, supra at 6), but the JRC will continue to consider the issue.

Intangibles

Under Section 9-309(1), purchase money security interests in consumer goods are perfected automatically upon attachment. (Note that for motor vehicle liens, the security interest in the primary collateral is perfected under state certificate-of-title statutes. Section 9-309(1) applies to all other consumer goods.) Transactions involving consumer goods, however, often also include extensions of credit for intangibles, such as warranties, maintenance services and insurance, that are not included under the definition of “consumer goods.” Liens on such intangibles neither enjoy purchase money status nor benefit from Section 9-309(1)'s automatic perfection provisions. Consequently, the question has arisen as to whether automatic perfection should be extended to include such intangible collateral when it is purchased in conjunction with traditional consumer goods. The Review Committee noted that such an expansion would reflect a policy change that would need to be justified, but left this issue to consideration by the JRC. (Review committee, supra at 9.)

Commercial Money Center

The In re Commercial Money Center, 350 B.R. 465 (B.A.P. 9th Cir. 2006) decision has provoked significant discussion among commentators. (For further discussion of Commercial Money Center, see A. Christenfeld & S. Melzer, “Securitization of Payments Under Equipment Leases” 238 NYLJ, No. 67 at 5 (Oct. 4, 2007). There, a bankruptcy appellate panel stated that a right to payment on chattel paper when “stripped” from the underlying chattel paper and assigned separately becomes a “payment intangible.” This characterization is important because sales of payment intangibles are perfected automatically under Section 9-309 whereas sales of chattel paper can be perfected only by taking possession or control of the chattel paper, or by filing. Because automatic perfection creates a hidden lien that cannot be discovered with reasonable diligence, chattel paper financiers or buyers cannot be sure whether the payment streams arising from the chattel paper have previously been sold. Moreover, it is unclear whether the super-priority rules of Section 9-330 benefitting good faith purchasers of chattel paper who take possession or control would defeat the automatic perfection priority status of holders of the stripped out payment rights.

The concerns raised by Commercial Money Center could be addressed several ways. The case's holding could be rejected altogether, for example, simply by revising Article 9 to make clear that payment rights stripped from chattel paper are not payment intangibles. Alternatively, the JRC might recommend that stripped rights to payment be treated as payment intangibles but that the official comments be modified to reduce confusion over the priority concerns and other problems generated by Commercial Money Center. In any event, it is important that any recommendations from the JRC address fully the issues resulting from this decision.

Highland Capital

Another case generating confusion is Highland Capital Management v. Schneider , 8 NY 3d 406, 866 N.E.2d 1020 (2007). There, the New York Court of Appeals held that promissory notes that were part of a class or series constituted “securities” under Article 8. The court reasoned that because the promissory notes were represented by certificates, their transfer could be recorded in transfer books by the issuer as required by Section 8-102(a)(15)(i). The promissory notes thus met the definition of securities under Article 8 whether or not such records were actually maintained. Although the decision affects primarily Article 8, it has created uncertainty under Article 9 as to the proper characterization of ' and, in turn, the proper method to perfect liens upon ' certain promissory notes and uncertificated certificates of deposit. The JRC will therefore consider whether the definitions of “promissory note” and “security” should be modified so that promissory notes issued as part of a class or series are not deemed securities under Article 9.

Conclusion

Revised Article 9 generally is working well, but the experience of the past seven years has shown that certain provisions could use refinement. The issues addressed above represent just some of the key areas where changes will be considered and might be implemented in the future. Practitioners may wish to familiarize themselves with the JRC's activities and recommendations as they unfold.

This article originally appeared in the New York Law Journal, a sister publication of this newsletter.