Best Practices: Perfecting Liens on Non-Real Estate Collateral

One of the top reasons for a repair of an SBA guaranty is failure to obtain the required lien position on business assets. This closing error is easily avoided if the lender has systems in place to ensure that UCCs are filed properly and timely without any intervening liens. Below is a primer on the basics of the Uniform Commercial Code as it specifically relates to SBA lending.

The Uniform Commercial Code, which has been adopted by most states, sets forth the requirements that a secured party must follow to establish a recoverable interest in non-real estate assets. In order to establish a priority lien position against the assets of a borrower, a lender must obtain a grant of a security interest and timely perfect its security interest.

In order to obtain a security interest, the borrower must execute a security agreement in favor of the lender. With the security agreement, the borrower is agreeing that the non-real estate assets of its business may be used as collateral for the loan and that the lender may liquidate those assets following a default. This language constitutes the grant of a security interest. In order for the security agreement to be effective in most states, a lender must ensure that it contains proper grant language, it properly describes the collateral and it names the lender as the party that benefits from the security interest.

The grant of the security interest alone, however, will not establish the lender’s priority interest. In order to establish priority, the lender must perfect and put other creditors and potential creditors on notice. In order to do this, it must follow the guidelines set forth in the Uniform Commercial Code. Requirements for perfection are different for different assets, but for most SBA loans, a lender would perfect its interest by filing a UCC financing statement.

When filing a UCC financing statement, the lender must first ensure that there are no intervening liens ahead of it and that it is filing in the proper jurisdiction. For a corporation or an LLC, the proper jurisdiction is the state in which the entity was formed. A lender should start by ordering a search in the proper jurisdiction to see if there are any liens recorded that would prevent it from obtaining the expected lien position. If there are, it should make sure all liens are paid and terminated or subordinated to the new security interest. The UCC financing statement should include the legal name of the borrower, the name of the lender, and a description of the collateral. After the UCC is filed, the lender should obtain another search to ensure that no other financing statements were filed in the gap between when the first search was run and when the lender recorded its UCC. This also allows lenders to confirm that its UCC was filed properly and in the correct jurisdiction. UCC financing statements expire after 5 years. To the extent that the financing secured by the UCC has a term that is longer than 5 years, a lender must file a continuation of the UCC prior to its expiration. Failure to do so may result in a lender losing its lien position with respect to the collateral.

In order to protect the interest of the bank and avoid any potential repairs for failure to perfect a security interest in business assets, lenders should follow the Uniform Commercial Code as it has been adopted by the applicable jurisdiction. For more information on security interests and UCCs, contact Jessica Conn at 267.470.1188 or jconn@starfieldsmith.com.