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July 1, 2015

Best Practices: Obtaining a First Priority Security Interest in Fixtures

by Victor A. Diaz

Fixtures are defined by the Uniform Commercial Code (the “Code”) as “goods that become so related to real property that an interest in them arises under real property law.” U.C.C. §9-102(a)(41). Generally speaking, these are items not easily removable and they effectively become part of the land. Examples of fixtures may include items such as leasehold improvements, sprinkler and HVAC systems. Goods, on the other hand, are generally items of personal property that are movable when the security interest attaches. U.C.C. §9-102(a)(44). In practice, determining when a “good” becomes a “fixture” requires a complicated analysis that is largely dependent on the circumstances, state real estate law, and which is, in the end, imperfect at best.

Courts have attempted to clarify this ambiguity as to when a good becomes a fixture by promulgating a three part test: 1.) has the good been attached to the real property; 2.) does the good benefit, or is it integral to the use or operation of the real property; and 3.) whether the party affixing the good to the real estate intends for the good to become part of the real estate. Teaff v. Hewitt (1853), 1 Ohio St. 511, 530. However, this test is one that must be performed on a case by case basis, and, even when applied, does not provide a level of certainty that most secured lenders would be comfortable with. So what should secured creditors do when financing fixtures or goods that may become fixtures?

A secured party financing fixtures has two options for obtaining a valid security interest, in addition to recording a mortgage or deed of trust. The first option is to file a UCC-1 financing statement with the state office or agency duly authorized by each state for central indexing, typically the Secretary of State, identifying fixtures as part of the description of collateral. The Code requires the secured party to include in the fixture filing: (i) the name of the debtor, (ii) the name of the secured party; and (iii) a description of collateral. While this filing will perfect the secured creditor’s interest in the collateral, it will only provide a priority lien for the creditor’s interest in goods that have not yet become fixtures.

The second option is to file a “fixture filing.” U.C.C. §9-102(40). The term “fixture filing” is a defined term under the Code, meaning a financing statement recorded in the real property records and whose content also includes: (i) an indication that it is to be recorded in the real estate records, (ii) the description of the affected property; and (iii) the name of the record owner of the real property. This additional information is necessary to properly index the filing in the real property records. The fixture filing is the only method to properly perfect an interest in goods that have become fixtures that will have priority over all other creditors.

The main difference between the two methods of perfection is the priority of the security interest in the fixtures. A security interest in fixtures that is perfected by a fixture filing will have priority over one perfected by a UCC-1 filed in just the central state office. Because determining when a good becomes a fixture can be difficult, the best practice for a Lender seeking to place a lien on fixtures, or goods that may become fixtures, is to file a UCC-1 covering, at a minimum, goods and fixtures at the state level and record a fixture filing in the real property records for the county in which the real estate is located.

For more information on best practices for lenders to perfect their security interests in fixtures, please contact Victor at 407-667-8811 or at vdiaz@starfieldsmith.com.