What is a Purchase Money Security Interest (PMSI)?
A purchase money security interest (PMSI) is a type of lien that gives the seller of goods priority over other creditors in reclaiming the goods if the buyer defaults. It’s an important concept in commercial lending and transactions.
The Uniform Commercial Code (UCC) governs these types of liens. The UCC is pretty confusing, even for us lawyers, heh. But let me break down PMSI liens into simple terms.
The Basics
When a seller finances a purchase for a buyer, they can take a PMSI lien on the goods sold. This gives them priority over other lenders if the buyer doesn’t pay.
For example, say Dealer Dan sells a tractor to Farmer Fred for $10,000. Fred doesn’t have the cash, so Dan finances the purchase and takes a PMSI lien on the tractor.
If Fred later defaults, Dan can repossess that tractor first – even if Fred has loans from other lenders secured by the same tractor. Sweet deal for Dan!
The logic is that Dan wouldn’t have sold the tractor without that assurance of first dibs if Fred doesn’t pay up. So the UCC carves out PMSI liens as an exception to the normal “first in time, first in right” priority rules.
-Requirements for PMSI Liens
To have an enforceable PMSI lien, a few requirements must be met:
The credit must enable the buyer to purchase the goods. So Dan can only take a PMSI if he’s financing Fred’s actual purchase of the tractor. If he lends Fred money later on for other stuff, no PMSI for Dan!
The lender must take the PMSI lien at the time of purchase. Dan needs to secure his interest when the sale happens, not after the fact. Again, the logic is the sale wouldn’t happen without the secured financing, so PMSI liens get superpower status!
The PMSI must be “perfected”. To perfect a lien means to put other creditors on notice by making public filings. Each state has its own rules here. But the UCC says PMSI liens generally need to be perfected within 20 days after the debtor receives the goods.
So Dan will likely need to make a UCC-1 filing to lock in his super lien within 20 days of Fred taking delivery of that sweet tractor.
PMSI Liens vs. Other Security Interests
Let’s say Fred previously borrowed $5,000 from First Bank and gave them a generic security interest in all his farm equipment and machinery.
First Bank filed a UCC-1 financing statement to perfect their lien. So at first glance, First Bank would have priority over Dan’s later PMSI lien on the tractor.
But because Dan holds a PMSI, his lien jumps ahead of First Bank’s! His interest attaches specifically to the sold tractor, so he gets first dibs despite First Bank’s earlier filing.
If Fred defaults, Dan can repossess and sell the tractor first. Only after Dan’s PMSI lien is satisfied does First Bank get a bite at the apple with any proceeds left over.
So again, that superpower PMSI status lets Dan cut in line ahead of other creditors. Nice perk for making the sale happen!
When PMSI Liens Get Complicated…
Purchase-Money Security Interest in Inventory
Let’s say Dan isn’t just selling Fred a tractor, he’s going to be Fred’s equipment dealer selling him inventory on credit over time.
Dan can still take a PMSI, but it gets more complicated. The UCC says retailers like Dan need to follow special rules to maintain their PMSI superpowers over inventory collateral.
If they don’t dot their i’s and cross their t’s just right, they risk losing the priority status over other lenders. Tricky!
Cross-Collateralization Concerns
Another complexity comes up when sellers start cross-collateralizing PMSI liens.
For example, Fred buys that first tractor from Dan on credit. A year later, he comes back to buy a combine on credit.
Dan says “Sure, I’ll finance the combine…and I’m taking a new PMSI lien on both the combine AND the old tractor!”
By taking PMSI liens on both old and new equipment, Dan secures his interest in all the stuff he’s sold Fred over time. Convenient for Dan, not always fair for other lenders.
The UCC tries to limit these “add-on” PMSI liens. They want to keep the super-status strictly tied to enabling new purchases, not securing past debts. But the lines still get blurry with retailers and dealers financing inventory over time.
-Consumer Goods PMSI Liens
Here’s another quirk – PMSI liens on consumer goods work differently. The UCC has special protections where household goods are concerned.
Say Dan isn’t a tractor dealer, he runs a furniture store. He sells Amy a nice living room set on credit.
Dan can take a PMSI lien to secure financing that purchase. But if Amy defaults, Dan faces more restrictions repossessing and selling household goods from little old ladies. No superpowers over couches!