The Limits of Liens in Proceeds Under Article 9

An Article 9 lien automatically attaches to the proceeds of a secured party's collateral, even if the security agreement does not specifically say “proceeds.” U.C.C. ” 9-203(f) and 9-315(c); U.C.C. ' 9-102(a)(12); City of Chi. v. Mich. Beach Hous. Coop., 242 Ill. App. 3d 636, (Ill. App. Ct. 1993). Thus, upon the sale, lease or licensing of a secured party's collateral, the lien follows and attaches to the proceeds automatically and without further notice or action by the secured party. However, as discussed below, this lien in proceeds becomes unperfected on the 21st day after the security interest attaches to the proceeds unless extended under U.C.C. ' 9-315(d). Notably, the secured party is authorized to file a financing statement against the proceeds to extend the lien beyond 20 days, again even if the security agreement does not expressly cover proceeds. U.C.C. ' 9-509(b)(2).

Proceeds Defined

Article 9 has an expansive definition of “proceeds,” including dividends on investment property and rents and royalties arising out of the leasing of goods and the licensing of general intangibles. U.C.C. ' 9-102(a)(64). “Proceeds” does not, however, include accounts receivables generated by the use of equipment in the ordinary course. 1st Source Bank v. Wilson Bank & Trust, 735 F.3d 500 (6th Cir. 2013).

This expansive definition of proceeds, when coupled with a thorough understanding of the perfection of liens in proceeds, can provide a secured party with all sorts of unintended collateral, including even collateral types not covered by Article 9. For example, Article 9 generally does not apply to insurance (with the exception of health care receivables), yet proceeds clearly includes insurance proceeds to the extent paid due to the loss or destruction of collateral. In re Wiersma, 56 U.C.C. Rep. Serv. 2d 452 (B.A.P. 9th Cir. 2005), aff'd in part, rev'd in part, 483 F.3d 933 (9th Cir. 2007): See also In re Tower Air, Inc., 397 F.3d 191 (3d Cir. 2005). Business interruption insurance may even come within the definition of “proceeds.” In re Kroehler Cabinet Co., 1992 U.S. Dist. Lexis 22166 (W.D. Mo. 1992); In re Bell Fuel Corp., 99 B.R.602, (E.D. Pa.), aff'd, 891 F. 2d 281 (3rd Cir. 1989); But see In re Montreal Maine & Atlantic Railway, Ltd., 2014 Bankr. Lexis 1628 (Bankr. D. Maine 2014) (the secured party's lien did not include general intangibles and the secured party did not make a “proceeds” argument).

Thus, a secured party may be entitled to insurance proceeds even if it is not a loss payee on the policy. Notably, however, if the secured party is not a loss payee, the insurance company is not obligated to protect its interest. Fidelity Fin. Servs. v. Blaser, 889 P.2d 268, (Okla. 1994). Indeed, at least one court has held that a junior lienholder had priority to an insurance check, as insurance proceeds, where the insurance policy listed the junior lienholder as loss payee. In re Courson, 409 B.R. 516 (Bankr. E.D. Wash. 2009). Therefore, the secured party must insist that the debtor have insurance and that the secured party is named as a loss payee. (It's also a good idea to be named as additional insured so the secured party has the same defense/claim rights as the primary insured.)

Article 9 generally also does not apply to litigation, with the exception of commercial tort claims. However, through claims to proceeds a secured party can often reach non-commercial tort claims. For example, a breach of contract claim in litigation is likely to be proceeds of an account or a general intangible.

Additionally, Article 9 does not generally apply to the assignment of an interest in a judgment, but again, the secured party's claim to proceeds can reach certain judgments, namely these judgments arising from the original collateral. If, however, the claim in the litigation was not a commercial tort or breach of contract claim, but was a personal injury claim, it could not have been the subject of an original collateral claim and can only become subject to Article 9 when and if it is settled and becomes an obligation to pay, at which time it is a payment intangible. See U.C.C. ' 9-109, Comment 15.

Thus, a secured party cannot obtain a security interest under Article 9 in a personal injury case unless and until it has settled and become an obligation to pay, such as a structured settlement. Two significant issues arise in connection with the sale or pledge of structured settlements. First, under the free alienability rules of 9-408, a contract provision barring the pledge or assignment should not stop the pledge or assignment. Enforcement by the assignee may be more problematic, however, because under 9-406 (e), in the case of an outright sale of a payment intangible the obligations of an account debtor to pay an assignee upon notice under 9-406 (a), do not apply. Other contractual restrictions or enforcements, which are valid under non-Article 9 law may also apply. Second, while perfection would be automatic under Article 9-309(3) in the case of an outright sale, a financing statement would need to be filed in the case of a pledge. Most states also have legislation requiring a court order for the sale of structured settlements. See Henderson Receivables Organization LLC v. Sioteco, 69 U.C.C. Rep. 2d 22 (Cal. Ct. App. 2009).

Lien Perfection

As noted above, the lien in proceeds only continues to be perfected for 20 days, unless extended. Pursuant to U.C.C. ' 9-315(d), the perfection of the lien in proceeds continues beyond 20 days under the following circumstances:

(1) The following conditions are satisfied:

(a) A filed financing statement covers the original collateral;

(b) The proceeds are collateral in which a security interest may be perfected by filing in the office in which the financing statement has been filed; and

(c) The proceeds are not acquired with cash proceeds;

(2) The proceeds are identifiable cash proceeds; or

(3) The security interest in the proceeds is perfected other than under ' 9-315 (c) when the security interest attaches to the proceeds or within 20 days thereafter.

(Note: U.C.C. ' 9-315 is not limited to non-titled collateral, but applies to proceeds of liens perfected in titled collateral as well. See U.C.C. ' 9-315 cmt. 6.)

Sub-section (2) above is the most well known sub-section of ' 9-315. Under sub-section (2), the lien perfection continues in identifiable cash proceeds indefinitely. Notably, this perfection continues even if the security interest in the original collateral becomes unperfected. U.C.C. ' 9-315(d)(2).

Cash proceeds are “proceeds that are money, checks, deposit accounts, or the like.” U.C.C. ' 9-102(a)(9). Even cash proceeds that are commingled with other property are identifiable proceeds “to the extent that the secured party identifies the proceeds by a method of tracing, including application of equitable principles, that is permitted under law other than this article with respect to the commingled property of the type involved.” U.C.C. ' 9-315(b)(2).

Thus, the fact that a secured creditor's cash proceeds are comingled, such as in a deposit account, is not fatal to the continuation of the lien perfection. Notably, however, in many cases, a purchaser or other transferee of cash proceeds will take free of the perfected security interest in proceeds. See, e.g.,U.C.C. ' 9-330(d) (purchaser of check), U.C.C. ' 9-331 (holder in due course of check), U.C.C. ' 9-332 (transferee of money or funds from a deposit account), U.C.C. ' 9-315(d)(2). There is also one other significant limitation on liens in cash proceeds: perfection under sub-section (2) is limited to proceeds of original collateral. The lien does not extend to cash proceeds of non-cash proceeds of original collateral. U.C.C. ' 9-315(d) cmt. 7. This exception is often overlooked by secured parties and should be invoked whenever a competing secured party is claiming a lien in proceeds more than once removed from the secured party's original collateral.

Under U.C.C.' 9-315 (d) (1), lien perfection in non-cash proceeds continues if: a filed financing statement covers the original collateral, one would perfect in the proceeds collateral by filing in the same locale that the secured party filed in, and the proceeds are not acquired with cash proceeds.

A good example of the application of this section is set forth in Example 5 of the Official Comments to UCC ' 9-322. In this example, secured creditor A files against inventory on May 1, and secured party B files against accounts on June 1 of the same year. Secured party A's lien in proceeds of the inventory will trump secured party B's lien in accounts. This exception is, however, very limited in the real world because it only applies if the proceeds are not acquired with cash proceeds.

In the real world, most assets acquired subsequent to disposition of the original collateral will be acquired with money or checks, such as where inventory is sold and the money, in the form of cash or a check is used to acquire equipment. Thus, in application this subsection is generally limited to a direct exchange of one type of collateral for another without cash collateral, such as a direct equipment-for-equipment exchange and accounts as proceeds of inventory.

Finally, under U.C.C. ' 9-315 (d) (3), the lien in non-cash proceeds continues if the security interest in the proceeds is perfected independently. Under this exception, the all-asset secured party may often claim priority in subsequently acquired collateral, such as where inventory is sold and the money (or a check) is used to purchase equipment.

Conclusion

The various U.C.C. provisions and case law governing liens in proceeds is an involved area of law, which requires careful examination and application to your specific set of facts. We leave you with on final practice tip: The secured party without an all asset filing should be sure to include broad “proceeds” language in its financing statement, such as, ” ' all products and proceeds of any of the foregoing including but not limited to, all assets and personal property constituting proceeds or proceeds of proceeds of the collateral described above.” The secured party should also consider filing a fixture filing, even though the original collateral is not fixture, in case any proceeds of the original collateral becomes fixtures.

Frank Peretore is a founding partner of the law firm of Peretore & Peretore, P.C. with offices in New Jersey and New York. A member of this newsletter's Board of Editors, he represents national and regional financial institutions and lessors from the transactional and financing stage throughout the litigation stage in the state, federal and bankruptcy courts. He may be reached at 973-729-8991.