UCC-1 Security

Security interests in accounts receivable, contract rights, and general
intangibles are generally the least favored types of collateral.  It is difficult to
perfect a security interest in contract rights or general intangibles.  It can
also be difficult to monitor your secured interest in accounts receivables and
receivables could decline due to dropped sales, or relaxed credit standards
may result in a decline in the quality of the receivables.  One way the credit
grantor can determine if the receivables collateral is safe, or declining, is the
“lockbox” method; through an agreement with the debtor, a special lockbox is
opened to track incoming receivables from the sale of specified inventory.  
(Also, certain agreements allow for direct payment to the holder of the
secured receivable.)

Another problem with securing receivables is that once they are received by
the debtor, the cash receipts are often commingled with the operating cash
of the company, thus making it hard to segregate exactly what cash belongs
to the creditor and what belongs to the debtor, aside from the security
agreement.  In this instance, the creditor’s rights may be lost.  Again, a wise
creditor may insist on a lockbox arrangement, including a separate bank
account to segregate the cash receipts.

Despite all of the shortcomings mentioned, receivables are very often
secured as collateral, often in conjunction with inventory, which may include
future inventory.

Companies that grant credit to companies with guarantees from subsidiaries
should always attempt to collateralize inter-company receivables from the
parent firm as well.  Liquid assets, such as cash and A/R, are sometimes
transferred to the healthy company, which may allow a less healthy and
highly leveraged subsidiary or sister company to file bankruptcy.

The Purchase Money Security Interest is a means for the credit grantor
taking a senior secured position with respect to a new piece of equipment.  If
perfected properly, the creditor holding this security will maintain seniority
over any other secured creditor for this newly acquired asset.  However, if
not perfected, a creditor may lose their senior standing with regard to the
asset.  It is a means for the credit grantor taking a senior secured position
with respect to a new piece of equipment.

Securing the Collateral

Once the type of asset to be pledged as collateral is identified by both the
creditor and the debtor, the debtor will sign a security agreement, which
formally grants security to the creditor and contains an accurate description
of the collateral.  The second part of the agreement declares the secured
item’s value.  Lastly, the debtor must have the item in his possession, or
present rights to it.  Inventory, accounts receivable, and equipment are the
three most common forms of collateral, with real estate also being prevalent;
however, the rules regarding real estate as collateral vary widely from state
to state.

A security interest in real estate is perfected, in most states, by recording a
properly executed mortgage deed of trust with the county offices where the
real estate is located.  Although an unrecorded deed may be enforceable
against the debtor, it is generally not enforceable against a good faith
purchaser.  Where the debtor has attempted to give more than one lien on a
piece of real estate, some states hold that the first recorded deed is senior,
while other states tend to liberalize this rule in favor of the creditor who takes
his mortgage first, but fails to have it recorded first by losing the race to the
courthouse.

Perfection of Security Interest

Once the lender’s proposed security has been attached, the next concern is
whether it has been previously perfected.  This relates to whether the
security interest is enforceable against competing creditors and good faith
purchasers.  Personal property collateral is perfected when the financing
statement (typically a UCC-1 Financing Statement) is filed with the
appropriate state or local office.  Most states require central filing with the
secretaries of state.

Some items, such as stocks and bonds, are required only to be in
possession of the secured creditor, rather than by filing a financing
statement.

When filings move from state to state, disputes often arise as to when the
creditor must re-perfect, as to which state’s laws apply.


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