When it comes to business assets, sometimes it’s hard to tell which creditor comes first. If you have one lender with a major lien on everything and then borrow from another lender to buy a machine, they can wind up arguing over who has the right to that machine. The UCC governs all this, and the reality isn’t always what you’d expect.
Floating Lien
Start with your main lender. When the lender gives you the money, you sign a contract that says that the lender has a lien on all of your personal property, which is everything except real estate. They call it an ABA filing, or all business assets. They also call it a floating lien. This means they have a claim on what you already own and what you acquire later. Lenders claim this by filing a UCC-1 financing statement in the appropriate filing office, listing the collateral as “all assets” or “all personal property” of the borrower.
If you borrowed from one lender and then from another, the second lender will want the first one out of your hair. They’ll ask for the first debt to be paid off or for a lender to agree it is junior to the second lender’s security interest. The general rule after that is set by Section 9-322(a) of the Uniform Commercial Code: conflicting security interests in the same collateral rank by when they were filed or perfected. That is, whoever perfects the security first gets the jump. You might think the first lender would always have first priority, because the UCC says that, but there are some exceptions.
Trump the First-in-time Rule
The big exception is that properly perfected purchase-money security interests (PMSIs) trump the first-in-time rule. In a UCC Section 9-103 type of loan, the lender lends money for the explicit purpose of buying the goods or software, and you spend the cash only on that specific purchase. A common example is equipment financing. Surprise: even if the bank’s security interest is older, the PMSI lender’s claim to that particular item can be superior.
The rule for equipment sits in Section 9-324(a) of the UCC. Subject to a few exceptions, a perfected purchase-money security interest (PMSI) in goods other than inventory or livestock has priority over a conflicting security interest in the same goods, and a perfected PMSI in the identifiable proceeds of those goods has priority over a conflicting security interest in the same proceeds. As long as the PMSI is perfected when the debtor receives possession of the goods or within twenty days thereafter, all is well, even if the purchase-money lender knows about the senior lender’s prior all-assets UCC-1 filing. “Goods” are defined as all movable things when a security interest attaches, and “equipment” as all goods except inventory, farm products or consumer goods. And neither you, the borrower, nor the purchase-money lender have to tell your prior senior lender about the new loan.
Getting a priority over someone else when the loan is a “purchase-money” loan for the inventory itself is different. Your purchase-money lender has to perfect its security interest when the debtor gets possession of the inventory; send a written notification to the existing secured party; the notification must be received by the existing secured party within five years before the debtor receives possession of the inventory; and the notification must state that the sender has or expects to acquire a purchase-money security interest in inventory of the debtor and describe the inventory. The notice requirement applies only if the preexisting security interest is represented by a financing statement covering the same type of inventory that was filed before the purchase-money financing statement.
Constraints on the Borrower’s Capacity to Assume Additional Debt
This is where it bites you. Credit agreements for senior secured credit facilities typically include constraints on the borrower’s capacity to assume additional debt or impose liens on its assets. Diligent borrowers sometimes negotiate exceptions, known as Permitted Liens or Permitted Indebtedness, which allow them to take on a specified volume of other debt or liens. If you don’t have one of those allowances, then by taking on purchase-money financing, you have breached the deal, and the senior lender’s security interest in the financed goods is now subordinated. The senior lender, once it finds out, will question you about the new debt and decide whether to give you a waiver or an amendment to allow it. If the business is already behind on other debts by then, this is a point where a business debt settlement company like ours can step in and negotiate with the lenders.
A common way this surfaces: A senior lender is modifying or extending a loan. During a UCC check, it finds that the business now owes another creditor and has granted a UCC lien covering some equipment, inventory, or other goods. That simple modification could turn into more than expected. For example, was the purchase-money security interest perfected? Did they file before the debtor took possession or within 20 days? This often becomes a fact question, and the senior lender may not know all the facts. Because a financing statement doesn’t have to show the loan amount on the UCC, the senior lender won’t necessarily know if the borrower violated loan covenants. As a practical matter, the senior lender needs to get more information from the borrower about the other debt. Sorting that out can take a lawyer. Delancey Street is not a law firm, and when litigation or bankruptcy is the right call, we refer owners to a vetted independent attorney.
The PMSI is a weird artifact of Article 9 that generally plays opposite to first in time, first in right, which most non-lawyers think applies to all secured lending. Analyzing this stuff needs experienced counsel. If your equipment lender, your bank and your other creditors are all pressing at once, a first conversation with us is free and confidential.
