January 17, 2018
Best Practices: Debt Refinance and Preserving Purchase Money Security Interests
by Starfield & Smith
SBA 7(a) loans in an amount greater than $350,000 and which are extended to refinance existing debt “must be secured with at least the same collateral and lien priority as the debt that is being refinanced.” SOP 50 10 5 (J) at pg 187. In order to determine what collateral and lien position is needed to preserve and protect the SBA guarantee, lenders are advised to review the UCC-1 financing statements recorded against the borrower and financing agreements associated with the debt being refinanced.
As a practical example, the SOP requires a lender refinancing a first priority “Blanket Lien”* obtain a first priority Blanket Lien in the collateral that secured the original debt. A creditor typically accomplishes this by recording a UCC-1 financing statement against a debtor’s already encumbered assets prior to or at the time of closing. Because lien priority is generally determined according to whichever financing statement was recorded first, the Blanket Lien securing the new lender will have a priority lien once the existing creditor terminates its senior financing statement.
Refinancing a Purchase Money Security Interest (“PMSI”) is more nuanced than refinancing a Blanket Lien. A PMSI is the interest a creditor has in collateral that was acquired with loan proceeds specifically intended to enable the debtor to acquire rights in or use certain collateral. Known as a “Super Priority”, the general rule is that a “perfected purchase-money security interest in goods…has priority over a conflicting security interest in the same goods.” U.C.C. §9-324(a). The Uniform Commercial Code (the “Code”) specifically states that a PMSI “does not lose its status as such, even if…the purchase-money obligation has been renewed, refinanced, consolidated, or restricted.” Id. at §9-103(f)(3) (emphasis added).
Case law has muddied the Code’s seemingly clear rule that a PMSI retains its super priority status when refinanced. In Lewiston State Bank v. Greenline Equipment, LLC, 147 P. 3d 951 (Utah Ct.App.2006), the Utah Court of Appeals ruled that a creditor’s PMSI was lost when existing debt was refinanced by a different lender. In Lewiston, the existing creditor issued a lien release, terminated its financing agreement, and did not assign the financing documents to the new creditor. Interpreting the aforementioned facts, the Utah Court of Appeals held:
A PMSI is extinguished upon satisfaction and termination of the purchase-money obligation, and the status of the original PMSI is not preserved unless the subsequent refinance is by the original creditor or its assignee, and even then, only to the extent all or part of the original purchase-money obligation remains owing.
Id. at 957. Although the above holding is arguably an exception to the rule, Lewiston creates uncertainty over how the Code may be interpreted and what steps a creditor refinancing a PMSI should take to retain the super priority lien.
Lenders, in particular those refinancing debt of other institutions, may wish to evaluate what actions are prudent so that a PMSI is viewed as not having been terminated. Some steps to consider including:
- Taking an assignment of the existing debt and UCC-1financing statement from the original creditor
- Incorporating language within the financing documents stating any PMSI has been renewed, refinanced, and/or consolidated via the SBA loan in accordance with U.C.C. §9-103(f)(3)
- Seeking a Subordination Agreement from 3rd party creditors with a perfected security interest in the same collateral captured by a PMSI
Determining what steps are best to refinance or assign a PMSI is loan specific and requires an analysis of the liens encumbering each borrower.
* As used in this article, the term “Blanket Lien” refers to a UCC-1 financing statement securing a creditor’s general right to all of a borrowers business assets.