Kenneth Weinberg,
Shareholder,
Baker, Donelson, Bearman, Caldwell & Berkowitz

Late last year, Dispatches from the Trenches focused on the increasingly common approach in our industry of describing collateral in financing statements as “all equipment leased or financed” or words of similar effect.1 Two additional holdings have further clarified the landscape and fortunately are consistent with the author’s initial analysis and conclusions last year.

Background

The prior edition of Dispatches from the Trenches provided some general information about the provisions in the Uniform Commercial Code (UCC) relating to collateral descriptions and focused on the original holding in In re I80 Equipment Leasing, LLC, where the collateral description referenced a separate security agreement that was not attached. The District Court in that case held the financing statement to be invalidated because, according to that court, it “on its face, provides no information whatsoever, and therefore no notice to any third party, as to which of the Debtor’s assets [the secured party] is claiming a lien on, which is the primary function of a financing statement.”2

In doing so, the District Court rejected the secured party’s argument that the collateral description complied with the requirements of the UCC provision providing that a description is effective if the identity of the collateral is objectively determinable, instead adding a requirement that the collateral must be “objectively determinable” from the description “in the four corners of the financing statement, including any filed attachments.”

As previously reported, this author believes the argument made by the secured party to be very cogent and consistent with the plain meaning and intent of the applicable UCC provisions, and that the holding can be criticized for a variety of reasons, including the fact that the District Court applied a stricter standard to the collateral description in a financing statement than it applied with respect to the collateral description required for the actual grant of the security interest. The above case is also clearly distinguishable from the types of descriptions used more frequently in the equipment leasing and finance industry. After all, filings referring to goods, which is a collateral category referring to “things that are movable when a security interest attaches,” or equipment which is a collateral category that is a subset of goods, or even further to only the portion of such collateral category that is leased or financed by the secured party.

Appeal of In re I80 Equipment Leasing, LLC

On appeal, the United States Court of Appeals reversed, basing its holding on certain founding principles of statutory interpretation, namely that clearly worded provisions should be interpreted consistent with their plain and ordinary meaning, and considered in light of other relevant provisions of the statute.3

The Appellate Court followed the cogent argument previously made by the secured party, noting that a “financing statement sufficiently indicates the collateral that it covers if the financing statement provides … a description of the collateral pursuant to [the section of the UCC setting forth the type of indication required for the grant of the security interest and that] a description of collateral reasonably identifies the collateral [for such purposes] if it identifies the collateral by [certain listed methods or] any other method, if the identity of the collateral is objectively determinable.”4

The Appellate Court also focused on the fact that, consistent with the concept of a notice filing, the indication of collateral required in a financing statement is a less stringent standard than the identification of collateral required for the grant of the security interest. To that end, the Appellate Court noted that “the ordinary meaning of ‘indicate’ is to serve as a ‘signal’ that ‘point[s] out’ or ‘direct[s] attention to’ an underlying security interest [and t]hat plain reading of the text allows a party to ‘indicate’ collateral in a financing statement by pointing or directing attention to a description of that collateral in the parties’ security agreement.”5

At the end of the day, even if construed narrowly, the Appellate Court’s holding allows a financing statement to incorporate by reference a properly identified security agreement which, itself, has an adequate collateral description. In particular, the Appellate Court states:

[I]ncorporation by reference is permissible in Illinois as “any other method” … so long as the identity of the collateral is objectively determinable. That requirement is met here by the security agreement’s detailed list of the collateral. There is no dispute that the financing statement names … both the debtor (I80 Equipment) and the secured party (First Midwest) [and] the date and precise title of the underlying document. It describes the security interest by referencing “[a]ll [c]ollateral” as described in the underlying security agreement between the parties. For its part, the security agreement references twenty-six independent categories of collateral covered by the agreement, including accounts, cash, equipment, goods, financial assets, deposits, investments, instruments, inventory, and all proceeds of any assets.

In re: the Financial Oversight and Management Board for Puerto Rico 

Another case, In re: the Financial Oversight and Management Board for Puerto Rico,6 decided earlier this year appears on first glance to mirror the original, now over-turned holding by the District Court. The collateral description on the financing statement in this other case was “[t]he pledged property described in the Security Agreement attached as Exhibit A … ”7 Although the security agreement was attached, it did not itself describe the “pledged property” but referenced a separate, unattached resolution that had the collateral description.

The Court asserted that the goal of the financing statement is to provide fair notice to other creditors and the public of a security interest and stated that the collateral description in this case was insufficient and therefore ineffective. However, this case involves various laws of the Commonwealth of Puerto Rico, and this holding fails to refer to any of the UCC provision that were quoted in the two In re I80 Equipment Leasing, LLC holdings, and which are directly on point. Moreover, the Court appears to acknowledge that its holding does not deal directly with those UCC provisions, stating:

We clear away some arguments which are beside the point. It is not helpful for the parties to use terms such as “liberal” or “strict” construction of Article 9. And it is likely that on some facts, incorporation by reference was permissible under the version of Article 9 operative in the Commonwealth when the 2008 Financing Statements were filed. That principle is not really at issue. On the facts on this record, we, like the district court, conclude that the 2008 Financing Statements were insufficient to perfect the security interest under P.R. Laws Ann. tit. 19, §2152(1) (2008) [(a different law than the UCC)]. There has been no literal compliance with this rule, and this provision should be interpreted consonant with the goals of the UCC.

In any event, even if this case were to be interpreted as standing for the proposition that, under the UCC in effect in Puerto Rico, merely referencing a separate document that is not attached or otherwise available in an identified public record does not sufficiently describe the collateral for perfection purposes, there is still a silver lining. In particular, the Court noted:

Our holding of an insufficient collateral description depends heavily on the facts, where a) the collateral is not described, even by type(s), in the 2008 Financing Statements or attachments; b) the 2008 Financing Statements do not tell interested parties where to find the referenced document (the Resolution) which contains the fuller collateral description; and c) the Resolution is not at the UCC filing office8.

As previously noted, the types of descriptions used more frequently in the equipment leasing and finance industry are clearly distinguishable to the extent they refer to “goods,” “equipment” or another type of collateral category.

The Integrity of the System- The Authority to File

As the saying goes, sometimes bad facts make bad laws. The two courts that held the general reference to a security agreement to be ineffective, one of which has been overturned, were heavily motivated by the fact that such cross-references provide little, if any, direction to a third party.

Although this author believes the courts have valid concerns, their solution of invalidating the financing statement is inconsistent with the plain meaning of the statutory language and the intent behind those provisions. This issue is already addressed elsewhere within the confines of Article 9. In particular, a secured party may not file a financing statement without the proper authorization of the debtor.8 The debtor’s execution of an agreement granting a security interest in collateral is automatic authorization to file a financing statement covering the collateral in which it has granted a lien.9 If a secured party files an unauthorized filing, it is liable for damages in the amount of any loss caused by such unauthorized filings, which “may include loss resulting from the debtor’s inability to obtain, or increased costs of, alternative financing.”10 In addition, statutory damages of $500 for each violation are also recoverable.12 In other words, a debtor who is harmed by a nebulous, broadly-worded filing that it has not authorized is already protected by the UCC.

On the other hand, the debtor can authorize a filing against broader collateral and may prefer to do so in order to streamline and accelerate the process of obtaining new financings from a given financing source. Indeed, a debtor who only grants a lien for specific goods or equipment leased or financed could still technically authorize that financing source to file a financing statement describing the collateral as “all assets of the debtor.” That filing would absolutely be effective since the description is specifically approved13 and authorized under the UCC.14 A different collateral description that is also broader than the collateral pledged, but narrower than an “all asset filing”, should also be effective if authorized.

General Thoughts and Conclusion 

Although the original holding by the District Court in In re I80 Equipment Leasing, LLC was disconcerting, that case has been overturned with a clear, well-written opinion by the Appellate Court. Although the Court in In re: the Financial Oversight and Management Board for Puerto Rico similarly invalidated a broad filing, and that decision has not been appealed, the decision fails to address the statutory language that is most on-point, technically relates to non-UCC law and can be distinguished from many of the filings used in the equipment leasing and finance industry.

Nonetheless, those relying on broadly worded filings should consider their language carefully. Referencing a specific agreement pursuant to which the goods are leased or financed, including the title, date and parties to such agreement, makes it more likely the filing will be honored by the courts. Secured parties relying on broad descriptions should also include language in their documents pursuant to which the debtor authorizes the secured party to describe the collateral in the manner in which the secured party determines best protects its interest regardless of whether such description is greater in scope than the collateral actually pledged the secured party.