In the first installment of a two-part series, Ken Weinberg dissects the super-priority rule as it relates to possessors and filers of chattel paper, examining the key requirements of new value and possession.
Active members of the equipment leasing and finance industry are often familiar with the super-priority rule contained in Article 9 of the UCC. Under certain circumstances, this rule allows a party that takes possession of chattel paper in connection with an outright or collateral assignment of chattel paper (possessor) to obtain a prior interest to another claimant who perfects its interest by filing (filer). The next two editions of Dispatches from the Trenches take a deeper dive into the text of this super-priority rule found in UCC §9-330. Part one discusses the super-priority rule generally and focuses further on the key requirements of new value and possession. Part two will address the two separate and distinct super-priority rules which apply in different contexts.
The UCC defines chattel paper as “a record or records that evidence both a monetary obligation and a security interest in specific goods… or a lease of specific goods.”1 The definition expands to include a security interest in, or license of, software used in connection with the specific goods.2 In the simplest terms, the vast majority of equipment leasing and finance transactions originated within our industry are reflected by one or more documents constituting chattel paper.
An assignment of this chattel paper falls within the scope of Article 9, irrespective of whether the transaction constitutes an outright sale of chattel paper or, alternatively, only a security interest in chattel paper.3 This rule is in effect because it is sometimes difficult to distinguish a true sale of chattel paper from an outright assignment.4 In both contexts, the UCC requires the assignee to perfect its interest in the chattel paper.
For this reason, two groups in our industry must be aware of the super-priority rule that allows a possessor to trump the interests of a filer even if the filer perfected its interest first:
In many transactions, the super-priority rule provides comfort to funders, leading to a belief that it will obtain a priority interest in the chattel paper in connection with an outright assignment. Often in the same transaction, the purchaser/assignee receives a representation and warranty from a reputable and established company that the assignor owns the chattel paper, has not assigned or pledged it to anyone else and is conveying it to the assignee free and clear of liens arising through or created by the assignor. A strong representation and warranty of this nature by a reputable and creditworthy entity can lessen the desire to walk through the text of the super-priority rule as carefully.
Unfortunately, the representation and warranty is not enough in many contexts, and a deep dive into the text of the rule may reveal some astonishing treasures or some surprises as intellectually shocking as a mythical sea creature.
Although other requirements will be discussed in the next edition of Dispatches, in all cases, a possessor can only take priority over a filer if three conditions are met. The possessor must:
Whether a possessor takes its interest in good faith and in the ordinary course of business is a factual matter not discussed in detail here.
Whether a possessor gives new value is worth further discussion. The UCC defines new value as “(i) money, (ii) money’s worth in property, services or new credit or (iii) release by a transferee of an interest in property previously transferred to the transferee. The term does not include an obligation substituted for another obligation.”5
Generally speaking, this rule means that the possessor has to provide new value for the assignment of the chattel paper. This requirement is satisfied when a funder/investor takes assignment of chattel paper from an originator. However, it should be considered carefully when a lessor/lender merely takes collateral assignment of chattel paper originated by its lessee/borrower as additional collateral in connection with an equipment lease or financing. In that context, the funds provided by the lessor relate to the acquisition or other financing of the equipment, and therefore may not constitute new value for purposes of the assignment of the chattel paper.
There is one notable exception in which “the holder of a purchase money security interest in inventory gives new value for chattel paper constituting proceeds of the inventory.” As the official comments to the UCC explain: “Accordingly, the purchase-money secured party may qualify for priority in the chattel paper under [the 9-330 super-priority rule], even if it does not make an additional advance against the chattel paper.”6 For this reason, a lessor/lender with a purchase money security interest in the leased or financed equipment has a stronger claim under the super-priority rule to the chattel paper than a lessor/lender that does not have a purchase money security interest. Note, all that is required is a purchase money security interest, not necessarily the priority that such an interest is afforded if the purchase money super-priority rules are followed.
Prudent equipment leasing and finance companies may also want to include specific language in any lease or financing documents where chattel paper is key collateral. The language should state that any advance by the lessor or lender of any funds in a connection with the transaction is being made specifically for the applicable chattel paper and that the lessor/lender is giving new value and otherwise qualifies for a priority security interest in chattel paper under §9-330 of the UCC.
Possession or Control
Possession seems to be a simple concept, but official comments to the super priority rule mention two common practices that have raised particular concerns.
The first problematic practice occurs when there are multiple originals of the chattel paper. The UCC notes, as follows: “In some cases the parties create more than one copy or counterpart of chattel paper evidencing a single secured obligation or lease. This practice raises questions as to which counterpart is the ‘original’ and whether it is necessary for a purchaser to take possession of all counterparts in order to ‘take possession’ of the chattel paper. The problem raised by [this] first practice is easily solved. The parties may, in the terms of their agreement and by designation on the chattel paper, identify only one counterpart as the original chattel paper for purposes of taking possession of the chattel paper.”7
The second problematic practice occurs when there is a master agreement with multiple schedules, each intended to evidence a different lease or financing. The UCC notes as follows:
“Parties sometimes enter into a single ‘master’ agreement. The master agreement contemplates that the parties will enter into separate ‘schedules’ from time to time, each evidencing chattel paper. Must a purchaser of an obligation or lease evidenced by a single schedule also take possession of the master agreement as well as the schedule in order to ‘take possession’ of the chattel paper?”8
Careful drafting also easily solves concerns about the second practice. Each schedule should incorporate the terms of the master agreement, not the other way around. This will make it clear that each schedule is a stand-alone document.
The concept of control is intended to be the high-tech equivalent of possessing electronic chattel paper. Because of the many wrinkles to this developing concept, which has been increasingly taking shape over the last several years, a detailed discussion is beyond the scope of this edition of Dispatches.
All of the above requirements apply anytime a possessor desires to take advantage of the super priority rule. There is also another element, which differs depending on the context. It may surprise some to learn that there are actually two separate and distinct super-priority rules, one which applies to an interest in chattel paper claimed merely as proceeds of inventory and another in which the interest is claimed other than merely as proceeds of inventory. The next edition of Dispatches will discuss this aspect of the super-priority rule. Until then, watch the new value and possession concepts carefully and stay dry.
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