Who gets paid first when a business can’t pay everyone it owes? The answer comes down to UCC lien priority. In plain English, a priority lien is a claim against your property for debt that’s arranged in order of who gets paid first. UCC lien priority is part of a state’s ”first-in-time first-in-right” rule for determining the priority of security interests in personal property. Personal property includes businesses’ accounts receivable, inventory and equipment. The rules come from Article 9 of the Uniform Commercial Code.
A UCC lien is a security interest on an asset given by a debtor to a secured creditor. If the debtor defaults, the secured creditor can then turn to the asset for satisfaction of the debt. A lender only earns that position by doing things in the right order. It starts with a security agreement for your business that grants them a security interest in your business’ property. The security agreement can only be enforceable if it contains a description of the collateral secured by the agreement, and the debtor must sign the security agreement. It also has to make clear that a security interest is intended. However, that is not the end of the story. In order to guarantee that the lien is “perfected”, it is up to the lender to file a UCC lien against your business with the Secretary of State’s office. The time when the security interest becomes effective and protected is when the filing of the UCC lien actually takes place. If multiple lenders file a lien against your business at different times, the first to file their lien is the first in priority and will get paid first. Without filing the UCC-1 Financing Statement, the lender is an unsecured creditor that is subject to the claims of the debtor’s other creditors.
”Priority” in this sense means that the first-to-file a financing statement that is perfected has the right to be paid before competing lienholders if the collateral is foreclosed or sold. The earlier in time that a document filed, the higher priority it has in payment. Each filing is recorded with the date and time it was made. This is why you should always check the timing. Priority also reaches past the collateral itself to its proceeds.
A ”blanket lien” is used by banks and lenders for a variety of situations. The term refers to the security interest that is taken on a borrower’s business assets for purposes of securing repayment of a loan. It is usually put in place by a bank as part of a loan to the business. Typically, these will identify things like all accounts receivable, inventory, equipment, fixtures and a catch all to any other property. In most cases, if there is bank financing, the bank’s perfected blanket UCC-1 is the one that takes priority.
There is one big exception to first in line, first in right: the purchase money security interest, or PMSI. A purchase-money security interest is a security interest in personal property that secures payment of all or part of the purchase price of the collateral. A supplier who sells you goods on credit can use one to prioritize his or her claim over an earlier secured creditor if the vendor has taken certain specific steps to ensure perfect priority. In a purchase money security interest, PMSI, the supplier’s security interest attaches only to the property it sells. It covers goods sold from that point forward, not debt you already owe, and you have to sign off on it. The secured party must give written notice to any prior secured creditors and perfect the security interest, and that notice has to go out before you take possession of the goods. A secured party (the party holding a secured claim) may agree to subordinate or defer to the rights of other secured parties. A bank usually won’t agree to that unless it decides it is in its own interest.
A Secured Creditor
Once a creditor is secured and you default, it has real options. It can foreclose on the asset that secures the loan, sell it, and take the proceeds as payment. It can also seek a judgment against you. A secured creditor, of course, wants to take back control of its collateral. In so doing, it has the right to charge the debtor reasonable fees for doing so. Before the lender sells, leases or otherwise disposes of the collateral, it must give you notice, usually 10 days. Any secondary lien holder has to be notified too. You will be responsible for paying the expenses of the sale and any deficiency resulting from a sale of the collateral that will not satisfy your debt. If there is a surplus in the proceeds of a sale, the lender must pay it to the creditor who has an interest in the sale after the lender has been paid. If there is no junior lien holder, the excess comes back to you. Up until the sale, you or a secondary lien holder can redeem the collateral by paying the full obligation.
A perfected UCC security interest will result in a creditor being treated as a secured creditor rather than an unsecured creditor. That status carries into bankruptcy, where a perfected secured creditor gets elevated priority and a defense against preference claims. In a liquidation proceeding, secured creditors are paid before unsecured creditors. A secured creditor is, essentially, someone with a lien that they were able to perfect. So if the company is liquidated, the secured creditor gets first crack at what is available. This is often where owners have to decide whether to negotiate, settle or file. We are not a law firm, and when bankruptcy is the better path, we refer owners to independent bankruptcy counsel.
An Error on the Form Can Cost You
But a mistake on the UCC-1 can cause the filing to lose priority. The UCC-1 can be a confusing form. UCC-1’s work because third parties look to them for information. UCC-1’s are a system of notice. If someone goes through files and can’t find a notice, then they can safely assume that there is no security interest in the collateral. In one case, a leasing company listed the debtor as “Wing Fine Food” when the business was Wing Foods, Inc. A search using the secretary of state’s search logic would not have turned it up, and the court found the filing fatally flawed. That mistake in naming caused the security interest to lose priority. In another case, a bank had no perfected interest in a debtor’s receivables because its financing statement never listed “accounts,” even though the security agreement did. These errors can cause a lender to lose its priority, and the lender could be relegated to the back of the line. An error on the form can cost you.
Assess Your Financial Situation
At this stage, it is important to assess your financial situation before taking action. Search for UCC liens by your company name in your state’s office of the Secretary of State. You might be surprised at what you find. If you are trying to negotiate a settlement with each creditor, the order in which they filed a UCC lien can impact the terms of settlement. A creditor will want to know what their priority is because generally, the first creditor to file their UCC lien has priority over other creditors. That is where a business debt settlement company like ours comes in. Our senior advisors negotiate with funders and lenders for less than the full balance owed, and we don’t sell you another loan.
The takeaway is that you need to know who has what lien and what the priority is. If you don’t pay the debts and then need to resort to bankruptcy, that first-to-file, first-to-win can impact you. A first consultation with Delancey Street is free and confidential, and if a cheaper option exists, we will tell you on that first call.
