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June 5, 2013

Best Practices: Timing to Perfect a Purchase Money Security Interest

by Kristen G. Dickey

The U.S. Small Business Administration (“SBA”) Loan Authorization requires lenders to obtain a “purchase money security interest” (“PMSI”) in personal property (including machinery, equipment, or inventory) when the personal property is acquired by a borrower using SBA loan proceeds. A PMSI is a powerful tool, because it will provide the lender, as the secured party, a super priority over a conflicting security interest in the same collateral, but the PMSI must be “perfected” by following the filing requirements of the Uniform Commercial Code (“UCC”).

The UCC defines a PMSI as a security interest that is: (i) taken or retained by the seller of the collateral to secure all or part of its price; OR (ii) taken by a person who, by making advances or incurring an obligation, gives value to enable the debtor to acquire rights in or the use of collateral if such value is in fact so used. UCC § 9-107 This means that a lender is eligible to acquire a PMSI when it provides a loan that enables a borrower to acquire goods and the funds are specifically used for that purpose (documentation required).

A lender must take special care to perfect the PMSI so that it is ensured a super priority over conflicting security interests in the same collateral. The UCC states that a perfected PMSI in goods (other than inventory or livestock) has priority over a conflicting security interest in the same goods (and, many times, identifiable proceeds) if the PMSI is perfected: (i) when the debtor receives possession of the collateral; OR (ii) within 20 days thereafter. Lenders must exercise caution, because a borrower could receive possession of a piece of machinery or equipment before the loan has closed and before the sale (using loan proceeds) is complete. The clock will run and the lender may lose its priority if the PMSI is not perfected within the 20 day timeframe.

With respect to inventory or livestock, a perfected PMSI has priority if: (i) the PMSI is perfected when the debtor receives possession of the inventory; (ii) the purchase-money secured party sends an authenticated notification to the holder of the conflicting security interest; (iii) the holder of the conflicting security interest receives the notification within five years before the debtor receives possession of the inventory; AND (iv) the notification states that the person sending the notification has or expects to acquire a PMSI in inventory of the debtor and describes the inventory. UCC § 9-324

For lenders that participate in the SBA loan program, SOP 50 10(5)(E) includes an added regulatory requirement that lenders confirm their correct lien position on the borrower’s assets as contemplated in the SBA Loan Authorization. A lender’s failure to adhere to the time limits and notice requirements required by the UCC for filing financing statements to perfect a PMSI or to resolve issues identified in UCC searches (such as a conflicting security interest) may create lien priority issues that can jeopardize lender’s SBA loan guaranty. The following articles include best practices to troubleshoot UCC search issues and pre-file UCC filing statements.

By pre-filing UCC financing statements, ordering UCC searches early in the loan process, and strictly following the UCC time limits and notice requirements, lenders will avoid the most common mistakes associated with obtaining the properly perfected lien position and protect their SBA loan guarantees.

For more information on PMSI security interests contact Kristen at KDickey@StarfieldSmith.com or at (407) 667-8811.

Please also see Kimberly Rayer’s February 2012 Article titled “Best Practices: Perfecting Against an Individual Debtor under the 2010 Amendments to UCC Article 9,” which identifies amendments to UCC Article 9 that will take effect on July 1, 2013.