Perfection and Priority of a Security Interest in Internationally Mobile Goods

As the Capetown Convention and its protocols spread their wings, there is no reason to limit their expansion to “high-value” mobile equipment: International registries should be established for all categories of mobile equipment that move in international commerce. UCC ' 9-311 is already set up to accommodate international registries authorized by statute, regulation or treaty of the United States, granting filings made under such auspices the effect of perfection under the UCC. And as international registries for the filing of notices of security interests in mobile goods are established, consideration should be given to eliminating the bifurcation in the choice of law rules of ' 9-301 to provide that even for tangible assets, both the perfection and priority of security interests should be governed by the law of the jurisdiction in which a debtor is located. To the objection that the jurisdiction where mobile goods are located should govern questions of priority arising under non-UCC law (e.g., mechanics' liens), the UCC already recognizes this possibility by its inapplicability to liens “given by statute or other rule of law” for services, materials, or the like, UCC ' 9-109(d)(2), and by the general conflicts-of-law principle that a jurisdiction has the power to apply local law if the jurisdiction has a materially greater interest in the issue before it than any other jurisdiction and applying other law would violate a fundamental policy of the forum jurisdiction. See, e.g., Restatement (Second) Conflict of Laws ' 187.

James F. Fotenos, a member of this newsletter's Board of Editors, is a partner with Greene Radovsky Maloney Share & Hennigh LLP, in San Francisco, where he specializes in container leasing, corporate finance and pass-through entities.

Assume an international bank, with branch offices in New York and the Cayman Islands, makes a secured loan to a newly organized special purpose entity, organized as a Bermuda exempted company, secured by all of the borrower's assets. Borrower's assets consist of marine cargo containers and the leases of such containers. Most of the container leases qualify as operating leases under U.S. generally accepted accounting principles (“GAAP”), with the balance of them qualifying as direct financing or sales type leases under GAAP. The loan and security agreements entered into by borrower and the bank stipulate New York law as their chosen law. There are numerous lessees of the containers owned by borrower: Such leases generally, but not universally, stipulate English law as their chosen law (others, at the insistence of the lessee, stipulate lessee's choice of law as the chosen law of the lease, such as Singapore law).

Lender requests your assistance in perfecting its security interest in borrower's assets as a first priority security interest in such assets.

Which Law Applies?

Even if the loan to borrower is made by the Cayman Islands branch of our lender, and thus neither lender nor borrower has any “presence” in New York (other than, not atypically, lender's counsel), the parties' choice of New York law should be effective, as New York permits parties to commercial agreements involving not less than $250,000 to “agree that the law of this state shall govern their rights and duties in whole or in part, whether or not such contract, agreement or undertaking bears a reasonable relation to this state.” NY Gen. Oblig. Law ' 5-1401(1).

Under UCC ' 1-301 (in New York, NY UCC ' 1-105) “when a transaction bears a reasonable relation to this state and also to another state or nation the parties may agree that the law either of this state or of such other state or nation shall govern their rights and duties.” By reason of NY General Obligations Law ' 5-1401, our lender's and borrower's selection of New York law to govern the loan and security agreements is deemed to satisfy this requirement, and accordingly for UCC purposes New York law shall govern the rights and duties of the parties under the loan and security agreements. Note, unless there is a material difference in the text or citation of New York's Uniform Commercial Code from that of the official text of the UCC, I do not separately cite the New York UCC herein.

But this choice-of-law provision is subject to several exceptions, including the selection of the law to govern “perfection, the effect of perfection or non-perfection, and the priority of security interests ' ” UCC ' 1-301(c)(8), NY UCC ' 1-105(2). Accordingly, notwithstanding our lender's and borrower's selection of New York law to govern their loan documents, if other law is specified in ” 9-301 through 9-307 of the UCC, then that law and not New York law shall govern questions of perfection and the priority of the lender's security interest in the borrower's assets. See, e.g., In re Salander O'Reilly Galleries, 453 B.R. 106, 131-132 (Bankr. S.D.N.Y. 2011).

The Choice of Law Provisions of UCC ' 9-301

UCC ' 9-301 stipulates the general rules governing the law applicable to the perfection and priority of a security interest in collateral within the scope of Article 9. Generally, the law of the jurisdiction where a debtor “is located” governs perfection and priority issues where the lender's security interest in the collateral is nonpossessory. UCC ' 9-301(1) (NY UCC ' 9-301(a)). The rules for determining the “location” of a debtor are set forth in ' 9-307. For a “registered” organization organized under the law of a state of the United States, the organization is deemed to be located in that state. A Delaware corporation is thus deemed to be located in Delaware, notwithstanding that it may not have an office (other than that of a registered agent) in Delaware.

But our debtor is a Bermuda exempted company. Not organized under the law of a state of the United States or under the laws of the United States, it does not qualify as a “registered organization” under the UCC. ' 9-102(a)(70).

To determine where our debtor is located, the rules of ' 9-307(b) apply: A debtor that is an organization but not a registered organization, such as our borrower, and has only one place of business, is located at its place of business. If it has more than one place of business, then it is located at its chief executive office. “Place of business” is defined in ' 9-307(a) as “a place where a debtor conducts its affairs.”

Let's assume that our borrower has a registered office in Bermuda, its containers are managed by an affiliate of the borrower organized as a Cayman Islands company, and that neither borrower nor the Cayman Islands manager has any office or place of business in the United States. (Officers and directors of the ultimate parent of both borrower and manager are resident in the United States, but borrower's position is that none of such contacts justify a finding that either borrower or manager has a “place of business” in the United States.)

So it would appear that, by operation of the general rule of ' 9-301(1), the law of Bermuda or the Cayman Islands will govern the perfection and priority of our lender's security interest in the container assets and leases owned by debtor. But before reaching that conclusion, we must examine ' 9-307(c), which qualifies the location rules specified for a non-registered organization by, in our instance, requiring that the putative “location” jurisdiction's law (Bermuda or the Cayman Islands) “generally requires information concerning the existence of a nonpossessory security interest to be made generally available in a filing, recording, or registration system as a condition or result of the security interest's obtaining priority over the rights of a lien creditor with respect to the collateral.” (“Lien creditor” is defined in ' 9-102(a)(52).)

Both Bermuda and the Cayman Islands have systems for recording “charges” on assets, but the question of whether a country's laws conform to the “equivalence” test of UCC ' 9-307(c) is a complicated one ' see generally Rosenberg, “Where to File Against Non-U.S. Debtors: Applying UCC ' 9-307(c) [Rev] to Foreign Filing, Recording, and Registration Systems,” 39 UCC L.J., Issue 2 (Fall 2006), and therefore let us assume (as is typically the case) that the transaction lawyers involved in our financing transaction conclude that neither Bermuda nor the Cayman Islands commercial law qualifies under the equivalence test of ' 9-307(c). (For a recent decision directly confronting this general question, as between two competing secured parties, one perfecting by filing in the District of Columbia and the second by filing in Sonora, Mexico, with the court concluding that Mexico's filing system in 2007 and 2008 did not meet the equivalence test of UCC ' 9-307(c), see Dayka & Hackett, LLC v. Del Monte Fresh Produce N.A., Inc. , 269 P.3d 709, 711-714 (Ariz. Ct. App. 2012), discussed in 28 Clarks' Secured Transactions Monthly 2-3 (June 2012).)

Where a foreign country's commercial law does not qualify under the equivalence test, ' 9-307(c) provides that a debtor organized in that country, such as our borrower, “is located in the District of Columbia,” a presumption characterized by a leading treatise as a “gigantic legal fiction,” 1 Coogan et al., Secured Transactions Under the Uniform Commercial Code ' 5.01 at 5-5 (Matthew Bender 2012).

And so, given that our debtor, the borrower, is deemed located for UCC purposes in the District of Columbia, our lender, to perfect its nonpossessory security interest under the UCC in borrower's container assets, chattel paper (e.g., the container leases), and accounts and general intangibles (e.g., the rentals and other payments due by the container lessees under the container leases) will file a financing statement on Form UCC-1 with the Recorder of Deeds of the District of Columbia. UCC ” 9-310(a), 9-312(a). Marine cargo containers are not subject to any federal law or international treaty covering the registration of a security interest granted in such type of equipment, such as are applicable to aircraft and ships, and thus the grant of a security interest in containers is not subject to other law that would take the grant of a security interest in such assets outside of the scope of the UCC, cf. ' 9-311, and containers are not manufactured or sold with certificates of title (as are motor vehicles) so as to require compliance with a certificate-of-title statute, cf. UCC ' 9-311(a)(2), (3).

Priority

Our lender, as a secured creditor, not only wants to be “perfected” with respect to its security interest in our borrower's assets, but it also has a keen interest in the priority of its security interest: It does a lender no good to be perfected but to stand at the end of the line of the claimants to a borrower's assets in the event of default by or the insolvency of the debtor. Secured lenders want a “first perfected priority interest” in the collateral securing their loans.

And here is where the choice-of-law issues under the new (i.e., 2001 revised) UCC get interesting. As noted above, ' 9-301 of the UCC generally provides that the law of the jurisdiction in which a debtor is located governs perfection and priority issues. But one of the exceptions to this general rule applies to tangible assets, such as goods (e.g., marine cargo containers) and “tangible chattel paper” (e.g., written leases): For such assets, the law of the jurisdiction in which such assets are located governs the “effect of perfection or nonperfection and the priority of a nonpossessory security interest in the collateral.” ' 9-301(3)(C), NY UCC ' 9-301(c)(3).

In our example, this provision means that our lender's priority in borrower's assets would be determined by the law of the location where borrower's containers are located (as to the containers) and where it maintains its leases (as to the leases). Containers are leased primarily to shipping lines, and are therefore typically on the high seas on container ships, in ports throughout the world, or in transit inland (hence the modifier “intermodal” when applied to cargo containers) on trucks or railroad cars throughout the world. So what the revised UCC simplified by its choice of law for determining the perfection of a security interest, it took away by its choice of law for determining the priority of a secured party's interest in tangible assets, particularly mobile goods that, by definition, move from one jurisdiction to another (or no jurisdiction when on the high seas ' under international law, a vessel on the high seas generally is subject to the exclusive jurisdiction of the nation under whose flag the cargo vessel sails ' United Nations Convention on the Law of the Sea, Nov. 16, 1994, High Seas, art. 92(1), 1994 U.N.T.S. 397, 433).

This wasn't always so. The pre (i.e., before 2001) UCC did not make this bifurcation between the law governing perfection and the law governing the “effect of perfection or non-perfection” (generally, priority) of a security interest in collateral: Under old UCC ' 9-103, the general rule was that both perfection and priority issues were governed by the law of the jurisdiction “where the collateral is when the last event occurs on which is based the assertion that the security interest is perfect or unperfected.” Old UCC ' 9-103(1)(b). Ironically, the old UCC made an exception for “mobile” goods, such as “shipping containers,” that has now become the general rule under the new UCC for such assets: The law “of the jurisdiction in which the debtor is located governs the perfection and the effect of perfection on non-perfection of the security interest”! Old UCC ' 9-103(b). (The old UCC had a variant of the “equivalence” test of current ' 9-307(c) in that, for those debtors located in a jurisdiction outside of the United States which did not “provide for the perfection of the security interest by filing and recording in that jurisdiction,” the law of the state in which the debtor had “its major executive office in the United States” governed perfection and priority issues.)

Why does the revised UCC bifurcate the choice-of-law selection between perfection and priority? The Official Comments to ' 9-301 explain the bifurcation in the law governing perfection from the law governing priority by reason of the “serious confusion” that could arise in a state where competing security interests arise in collateral located in that state if the competing claims are governed by priority rules of different jurisdictions. ' 9-301, Comment no. 7. Two of the members of the Article 9 Drafting Committee that prepared the 2001 revision of the UCC, Professor Neal Cohen and Ed Smith, in their perceptive article, “International Secured Transactions and Revised UCC Article 9,” 74 Chicago-Kent L. Rev. 1191, 1205-1206 (1999), explain the bifurcation as attributable to concerns over conflicts between non-Article 9 claimants to collateral and Article 9 claimants, noting that the Drafting Committee concluded that it would be “inappropriate for Article 9 to provide that the law of a jurisdiction other than that where the collateral is located would determine the relative rights of a person who has a lien on the collateral under the law of the jurisdiction where the collateral is located.”

Another explanation is offered by Professor Julian McDonnell in his chapter, “Choice of Laws,” in the Coogan treatise cited above, namely, that the drafters of revised Article 9 “may have feared opposition to the revision's requirement that filings as to assets of a domestic corporation be made in the debtor's state of incorporation,” Coogan, supra, ' 5.13[1], at 5-39, and therefore may have provided for the bifurcation in choice of law “to reduce opposition to the change in the place of filing rules.”

Whatever the explanation, the bifurcation in choice of law as to tangible assets between that governing perfection and that governing priority confronts lenders in the hypothetical addressed by this article with a mess: What good is a perfected security interest under Article 9 of the UCC in Article 9 collateral if the effect of that perfection is governed by the law of myriad (and, at the time the loan is made, unknown) jurisdictions?

Toward an International Registry and Harmonized Priority Rules

There are substantial efforts ongoing to harmonize secured transactions law. Two organizations spearheading these efforts are the United Nations Commission on International Trade Law (“UNCITRAL”) and the International Institute for the Unification of Private Law (“UNIDROIT”), see, e.g., UNICITRAL's excellent Legislative Guide on Secured Transactions (United Nations 2010) (designed to assist member states of the United Nations in developing modern secured transactions laws) and the Convention on International Interests in Mobile Equipment (the “Capetown” Convention). Under the Capetown Convention, which addresses the creation, recognition and enforcement of international interests in “high-value” mobile equipment, to which some 40 countries are parties, two protocols have been prepared, one on aircraft equipment, which became effective March 1, 2006, and the second, dealing with railway rolling stock, which was open to signature on Feb. 23, 2007 but has not yet entered into force. A third protocol under the Capetown Convention, dealing with space assets, is currently under development. Under the aircraft protocol, the registrar selected to operate the international registry is Aviareto, a joint venture between Sita SC and the Irish government, based in Dublin. See generally, Stanford and Porras, “The Preliminary Draft Protocol to the Convention on International Interests in Mobile Equipment on Matters Specific to Space Assets,” 43 UCC L.J., Issue 2 (April 2011) and Atwood, “The Status of the Mobile Equipment (Capetown) Convention ' Arrival of an International Registration System,” 39 UCC L.J., Issue 1 (Summer 2006).

As the Capetown Convention and its protocols spread their wings, there is no reason to limit their expansion to “high-value” mobile equipment: International registries should be established for all categories of mobile equipment that move in international commerce. UCC ' 9-311 is already set up to accommodate international registries authorized by statute, regulation or treaty of the United States, granting filings made under such auspices the effect of perfection under the UCC. And as international registries for the filing of notices of security interests in mobile goods are established, consideration should be given to eliminating the bifurcation in the choice of law rules of ' 9-301 to provide that even for tangible assets, both the perfection and priority of security interests should be governed by the law of the jurisdiction in which a debtor is located. To the objection that the jurisdiction where mobile goods are located should govern questions of priority arising under non-UCC law (e.g., mechanics' liens), the UCC already recognizes this possibility by its inapplicability to liens “given by statute or other rule of law” for services, materials, or the like, UCC ' 9-109(d)(2), and by the general conflicts-of-law principle that a jurisdiction has the power to apply local law if the jurisdiction has a materially greater interest in the issue before it than any other jurisdiction and applying other law would violate a fundamental policy of the forum jurisdiction. See, e.g., Restatement (Second) Conflict of Laws ' 187.

James F. Fotenos, a member of this newsletter's Board of Editors, is a partner with Greene Radovsky Maloney Share & Hennigh LLP, in San Francisco, where he specializes in container leasing, corporate finance and pass-through entities.