Spencer Fane LLP Logo

Proper Use of the UCC Article 9 “File Drawer” System to Address Unauthorized Terminations of UCC Financing Statements

Most security interests in personal property securing commercial loans are perfected by filing a Uniform Commercial Code (UCC) financing statement, typically with the secretary of state of the state of organization of the borrower if a registered organization or with the secretary of state of the state of the principal residence of an individual debtor. In most instances, the security interest of the lender first to file a financing statement has priority over security interests perfected by subsequent filings.

Article 9 of the UCC does not require the debtor’s signature on an initial UCC financing statement filing or the signature of the secured party on a UCC amendment terminating a filing. Instead, such filings must be “authorized” to be effective. UCC §9-509(a)(1). Initial financing statement filings (and amendments adding collateral) must be authorized by the debtor, typically by signing a security agreement granting the security interest or by separate writing or other record. UCC amendments terminating the effectiveness of a UCC filing must in almost every instance be authorized by the secured party. UCC §9-509(d).

The UCC File Drawer System

Under UCC Article 9, filing offices do not delete from their records expired or terminated UCC financing statements or amendments to those statements, including any amendment purporting to terminate those statements, until one year after the normal expiration date of the filing UCC §9-522(a)), in almost every instance five years after filing, which can be continued for additional five-year periods by filing an amendment within a six-month window prior to the expiration date. Under this “file drawer” system, the UCC records reveal all filings, including purported terminations and all “correction statements” filed by debtors who believe the filings against them are not correct. UCC §9-518(a).

Armed with such information, a proposed lender has the responsibility to inquire in order to confirm whether a prior security interest in fact still exists. Under the notice-filing policy adopted in Article 9, a UCC filing “indicates merely that a person may have a security interest in the collateral indicated. Further inquiry from the parties concerned will be necessary to disclose the complete state of affairs.” UCC §9-502, Official Comment 2.

The following is an example of how the UCC file drawer system is intended to work:

  • Secured Party 1 (SP1) files an initial financing statement 10-1-2003;
  • SP1 files a financing statement amendment on 9-1-2008 continuing the effectiveness of the original filing for a second five-year period, expiring 10-1-2013;
  • Debtor files an unauthorized financing statement amendment on 3-1-2009 purporting to terminate SP1’s filing;
  • Potential Secured Party 2 (SP2) obtains a UCC search from the Secretary of State on 6-1-2011.

That search will reveal all filings concerning the initial financing statement filed 10-1-2003, including the purported termination, because all filings regarding such original financing statement would be kept in the “file drawer” until 10-1-2014, one year after the expiration of the extended period of effectiveness of the original UCC filing. Armed with such information, the clear intent of UCC Article 9 is that it is SP2’s responsibility to inquire regarding whether in fact the original filing was validly terminated. If unauthorized, the “termination” is ineffective and SP1 would continue to maintain its priority position ahead of SP2 (if SP2 made a loan to the debtor) regarding the collateral of the debtor indicated on both the SP1 and the SP2 financing statements.

The Issue is Real

The following case illustrates that the “file drawer” system works only if SP2 reviews and properly analyzes the results of a UCC search and makes inquiries about prior filings.

In AEG Liquidation Trust vs. Toobro NY LLC, 932 N.Y.S.2d 759 (Sup. Ct. 2011), SP1 obtained a security interest in personal property assets of debtor and perfected it by filing a UCC-1 Financing Statement on 11-13-1996 and appropriately filed a continuation statement to continue the effectiveness of that filing through 11-13-2006. Debtor, or someone on behalf of debtor, filed a UCC Financing Statement Amendment on 2-7-2002 purporting to terminate SP1’s filing. That filing was not effective because it was not authorized by SP1. In 2005, SP2 became a creditor of debtor and obtained a security interest in debtor’s personal property assets and properly filed an initial UCC Financing Statement. In 2006, SP1 discovered the unauthorized purported termination and filed a “correction statement” in order to get into the “file drawer” the statement that the termination was unauthorized.

Under current Article 9 only debtors and not secured parties have the right to file a correction statement, but secured parties sometimes do so to make a record in the “file drawer” of their position regarding a prior filing. Proposed revisions to UCC Article 9 will allow secured parties as well as debtors to make such filings, which will be called “information statements.”

The court held that SP1’s security interest remained properly perfected and had priority over the security interest perfected by SP2. Apparently SP2 either did not run a UCC search or did not inquire about the supposedly-terminated UCC filing or SP1’s correction statement revealed by a search, in either case, to its detriment. UCC §9-210 provides a procedure under which SP1, at the debtor’s demand, will be required to make disclosure about the existence of and scope of any purported security interest. SP2 should have required its debtor to make that inquiry and provide SP2 with the results.

Unintentional Terminations

Although some unauthorized terminations result from fraud, according to various UCC filing services fraudulently filed unauthorized terminations make up only a small percentage of unauthorized terminations received by UCC filing offices. Most are filed unintentionally due to data entry errors and the simplicity of the UCC amendment form – the only two items that are needed are the initial financing statement file number and a check of the “termination” box. A typographical error on a termination in the financing statement file number or a misreading of the file number (e.g., if working from a less-than-clear scan or fax of an initial filing) could cause a termination statement to be filed against the financing statement whose number happens to match the filing number on the termination containing the typographical error.

Proposed Article 9 Comment Clarifies Searching Burden

In 2010 the National Conference of Commissioners on Uniform State Laws adopted UCC Article 9 amendments and recommended their passage by the states. To date, most states have either adopted or are in the process of adopting the revisions, generally with an effective date of July 1, 2013. Included in the recommendations is an addition to Official Comment 2 to UCC §9-518 regarding whether the initial creditor (SP1) or the subsequent creditor (SP2) has the burden of determining whether a UCC filing was authorized:

“Just as searchers [SP2’s] bear the burden of determining whether the filing of an initial financing statement was authorized, searchers [SP2’s] bear the burden of determining whether the filing of every subsequent record was authorized.”

This revision to Comment 2 was intended to correct a court’s improper interpretation in Roswell Capital Partners, LLC v. Alternative Construction Technologies, 2010 WL 3452378 (S.D. N.Y. 2010 that SP1 had the burden of inquiry regarding terminations filed in the UCC file drawer.

Although Official Comments are not a part of the UCC statute, they do reflect the position of UCC experts who developed the Article 9 revisions and customarily, but not always, are referred to by the courts to assist in applying the statute.

Hopefully, the combination of rejection of the position in Roswell by the ACG Liquidation Trust case and its repudiation by the proposed revision to Official Comment 2 to UCC §9-518 will put to rest Roswell’s erroneous allocation of burdens of inquiry.

What to Do?

A prospective lender (SP2) has the burden under UCC Article 9 to carefully review the results of any UCC search regarding its proposed borrower, including copies of all filings, and make inquiry regarding any termination statements or correction statements (and after July 1, 2013, assuming adoption of the latest proposed revisions to UCC Article 9 in the applicable state, any “information statements”) included in the “file drawer” covering UCC financing statements previously filed against the proposed borrower. As between two innocent parties, the prior-filed victim of an unauthorized termination (SP1) will prevail over a subsequently filing secured party (SP2) because a termination is only effective if authorized by the secured party, regardless of the loss incurred by an innocent subsequent filer. The burden is on the subsequent filer (SP2) to determine whether prior filings, including terminations, are authorized.

Thorough review of all the filings in the “file drawer” (especially any purported terminations) listed on a UCC search against a proposed borrower should be an integral part of the loan process. A lender who fails to do so risks losing the anticipated benefit of its security interest in the collateral being pledged.