If you want to shield your company’s assets from outside creditors, one option is to lend money to your own business. Structure the transaction properly, using collateral and liens on your company’s assets, and the holding company could be both your primary creditor and your primary protector.
It is both possible and proper to form your holding company and do things in a way that deliberately mixes debt and equity. When you lend money to the operating company, for example, you are a creditor. If you do it right, you can even use your ownership to secure your loans with liens against the operating company’s assets.
The law is technical, but a lien is not complete and can be disregarded by outside creditors unless it is perfected. The way you perfect a lien will depend on what it covers. For real estate, you want to record a mortgage, so you keep your priority claim. For personal property, the creditor files a UCC-1 form, which can cover new, existing or future assets.
When you lend the business money yourself, the “owner” takes a priority position as both owner and creditor. The loan is secured by liens and collateral. The two-company structure may give you more protection and flexibility.
Let’s say the business borrows money to buy a building. In this situation, the lender will want a lien against the asset. The holding company can lend money to the operating company to pay for the building, while the operating company holds title. The holding company ends up holding a mortgage on the building.
On cash borrowed to buy an asset, the purchase money creditor has a purchase money security interest. If you are a secured creditor with a purchase money security interest in the equipment, for example, the equipment has effectively no value for an outside creditor.
What happens if the business fails and closes its doors? A liquidation will give the holding company those assets and the right to their value. Any creditors stand in line behind you; they get only a percentage of the liquidated value, if anything.
When Rockefeller Center went bankrupt in 1994, none of the real estate was lost to creditors. The property then was worth roughly $1.3 billion. Rockefeller Center was owned by two partnerships, which had granted a lien of about $1.3 billion to a holding company, Rockefeller Center Properties.
The holding company and the operating company both do what they do best. The operating company buys, sells, and uses the assets.
A lien doesn’t have to be limited to just one asset or what the business already owns. Another option is to secure your holding company’s loans, including loans that cover operating expenses rather than purchases, with liens against the operating company’s present or future assets.
Another kind of debt could simply be the money the operating company owes you but has not paid, such as salary, bonuses, health plan or retirement contributions, or expense reimbursements. It is possible to give yourself a lien on the operating company’s existing and future assets to secure it.
A Mortgage Creates a Lien
On its face, a mortgage creates a lien in favor of the creditor on a particular piece of real estate. The promissory note is a separate paper that is the actual proof of the debt. The mortgage is a collateral securing the obligation created by the promissory note.
Mortgages vary state-to-state. In several states, a mortgage actually passes the title to a lender. In most states, title stays with the owner, and the mortgage only creates a lien in favor of the lender, much as with personal property.
The mortgage and the note must be recorded in the public records where the land is located to be valid against third parties, including later creditors. Recording means filing at the county courthouse or town clerk’s office.
If your mortgage is recorded, you have a superior claim to the property. But if there are competing claims, unrecorded liens may lose out.
First to file does not always win, but it is common. Many states give priority to the person who records first.
Laws differ from state to state, so you want to do things right, have everything in writing, and have your loan agreements reviewed by an attorney. A lawyer should see the documents and use the right forms for your state, including the acknowledgment wording a mortgage deed usually needs.
One downside of this structure is that lenders may be hesitant to loan money against the same assets to a company that has a prior lien in your favor. Asset-based lending is secured by collateral, usually equipment and inventory.
Lenders may want a first position lien. An operating company would obtain a waiver from the holding company so that a new lender can have first security interest in specific assets. That can give the company access to credit that might not otherwise be there, while your lien still keeps other creditors behind you.
It takes more than just recording or filing to create and perfect a lien. A proper lien is created by an agreement between two parties in an acceptable form, and a board resolution or other action is needed to establish the holding company’s authority to enter into that agreement. The agreement should be signed by an officer with proper authority. Recording gives outside creditors notice of the lien and perfects it, giving you priority over later creditors.
UCC-1 Form
For personal property, a UCC-1 takes the place of the mortgage. Personal property is all property not qualifying as real estate. Personal property includes anything you can pick up, like furniture and equipment, and inventory; here it means business property, not your private belongings.
It is filed and recorded with the secretary of state’s office, or possibly the county courthouse. The form for a UCC-1 may vary from state to state. In some states, if you use a generic form, it will cost extra to index your filing.
Filing the UCC-1 form validates your lien and notifies creditors of your claim against a particular asset. The lender uses it to describe the debt and to list the property covered.
By itself, it lasts five years, and you have to renew it by filing a continuation statement while at least six months remain before the term expires. Keep an eye on the expiration date. Have the filing officer note the file number, date and time of filing on your copy.
When it comes to personal property, the basic rules of priority differ from those for real estate. Your right as a secured creditor depends on getting priority under the law, usually Article 9 of the Uniform Commercial Code. Generally, first to record wins. There are exceptions, mainly for inventory and other property bought from an outside creditor.
With inventory, the lender that takes the lien to secure an existing debt loses out to a seller who takes a purchase money security interest as part of the sale, even if that lender filed first, unless the earlier lien is already perfected and its holder gives notice before the purchase.
The UCC-1 form is versatile. Fill in the forms, and you can secure property you already own, property you buy later, or an open account, which simply means future debt.
A floating lien can be a powerful tool. It means that when you acquire property or obtain credit later, those assets or debts become part of a lien in the form that created it originally. Property described in an agreement in a certain class, including property acquired later, is covered under the lien.
With a security interest in an open account, what is covered are debts owed to you. The debt you secure need not be for a particular asset. The debt for current or future transactions is secured by a lien in the agreement creating it, possibly with some exceptions.
Once you have filed the form, you can keep lending, while having that future debt secured by the form.
You Are Your Customers’ Creditor
Look at your invoices. You are your customers’ creditor. For sales to consumers of goods bought mainly for personal or household use, your lien is perfected without filing. When you sell to other businesses, a UCC-1 recording makes your lien valid.
You may use equipment in the office or on the road for the business and at home or for personal use, as often happens with home offices. If the use of an asset or account is a mix of home and business, the primary use will decide if your lien has to be filed. Time is one factor in deciding what is the main use of an item. Another possible measure is mileage. If it is mainly for business, you have to file the UCC-1 form.
A Chapter 7 bankruptcy court has ruled that a $3,000 computer bought for home office use was primarily for business and not consumer use. The item was bought with a retailer’s financing plan. But that merchant failed to record a security interest, so the lien was unperfected. The merchant lost the value of the computer sold, because the court ruled it to be for business, although it was for both personal and business uses.
If you sell on credit, have your buyer sign a statement saying the item is for personal use in the agreement, or file a UCC1.
Motor vehicles are handled differently. It is common to buy a car on credit, and it is possible to buy a business vehicle on credit in the same way. Here, a lien is generally perfected by noting it on the title to the vehicle and turning that in.
About Delancey Street
Delancey Street is a premier, and award winning, business debt settlement company that helps business owners nationwide. Our goal is simple: help you escape debt in a safe and legal manner. Based out of New York, we can help in 49 of 50 states. We tell you how it is; because your business and future is on the line.
