If you operate a small business and have outstanding loans, you probably gave a creditor a mortgage lien on real estate assets of the business and, quite possibly, your personal residence as well. You may not recall, however, that you probably also gave one or more lenders a lien on non-real estate assets of the business. This can include equipment, inventory or other personal property.
As we’ve written before, creditors who have a valid mortgage lien or other security interest (called “secured lenders”) don’t typically lose their liens if you file for bankruptcy protection. With certain exceptions, they can foreclose on mortgages and repossess personal property, even if you have other, so-called “unsecured” creditors (for example, a credit card lender). If, as we have also written previously, you are planning to wind up your business, this doesn’t make much difference to you. If you want to keep the doors open, however, holding onto your inventory, operating equipment and other property can be crucial.
In order to have a meaningful lien, a creditor must file evidence of it in the public records. The reason is simple: subsequent potential creditors should be able to search independently to confirm that assets they are about to take as collateral aren’t already subject to mortgages or other liens. If a creditor has filed correctly, it is said to have “perfected” its security interest. Subsequent creditors are deemed to be on notice of the lien, even if they elect not to search the record.
When the collateral is real estate, perfection is governed by applicable state real estate law. It is usually accomplished by filing a mortgage or deed of trust that names the creditor and debtor and adequately identifies the real estate.
When the lien is on personal property, notice is by filing a “financing statement”, also known by its form number (“UCC-1”). As with a mortgage, the creditor, debtor and collateral are listed. A material error in the information contained in a financing statement can make the lien “unperfected”. While the lien remains valid as between the debtor and creditor, this means that the secured creditor can’t enforce the lien as against others.
To ensure that a financing statement provides adequate notice, the Uniform Commercial Code (“UCC”) as adopted in the states contains various rules regarding its accuracy. The general thrust of each is to ensure that the statement is accurate enough to provide notice to potential subsequent creditors.
Recent decisions by bankruptcy courts in Kansas and North Carolina illustrate the importance of following these rules to the letter. In re Preston held that lender’s security interest in the debtor’s farm equipment was unperfected because the UCC-1 set forth the debtor’s name in a manner different from the way it appeared on his driver’s license, as required by Kansas law. The court in In re Jarvis found that listing the creditor in the UCC-1 as the parent company of the true lender made the financing statement void under the state’s version of the UCC.
As noted above, if you intend to wind up your business and file a Chapter 7 liquidation bankruptcy petition, the somewhat arcane rules applicable to security interests and financing statements aren’t especially important to you. You can let your creditors fight over which, if any, has the right to claim your business assets.
However, a creditor’s failure to perfect its lien may provide significant negotiating leverage if you’re trying to hold onto the personal and real property you need to keep operating. Our lawyers can determine whether a creditor’s interest may be subject to challenge due to a faulty lien filing under Colorado law. If you’re a small business owner and you are considering bankruptcy, schedule a no obligation consultation today by clicking here. We will help guide you through the bankruptcy process.