Using UCC Purchase-Money Priority to Grow C&I Loans
Alabama Bankers Association Board Briefs
If your bank is looking to grow its commercial and industrial (C&I) loan portfolio, consider taking advantage of the purchase-money priority provisions of Article 9 of the Uniform Commercial Code (the “UCC”). Those provisions, which permit a lender to obtain a “superpriority” security interest in goods that it finances under certain circumstances, may enable your bank to begin a secured lending relationship with a new customer, even if the customer has already granted a blanket lien on all of its personal property to another lender.
This article focuses on considerations related to the purchase-money financing of equipment. Purchase-money financing of inventory and livestock also can entitle a lender to “superpriority” under Article 9 and may present opportunities for your bank. However, special rules apply to purchase-money priority positions in those types of goods and are not addressed in this article.
- “Purchase-money security interest” defined. A security interest in equipment is a purchase‑money security interest (“PMSI”) if the security interest secures a loan made to enable the borrower to acquire the equipment, and the borrower, in fact, uses the loan proceeds to fund the acquisition.
- “Equipment” defined. Article 9 defines “equipment” to mean goods other than inventory, farm products, or consumer goods. Thus, “equipment” consists of finished goods used by the borrower in its business. “Equipment” does not include goods held for sale or lease, raw materials, work in process, or materials used or consumed in the borrower’s business, all of which are defined in Article 9 as “inventory”.
- Effect of PMSI priority in equipment. Under Article 9, a lender that has PMSI priority in equipment has priority—sometimes referred to as PMSI “superpriority”—that puts the lender ahead of other creditors that have competing security interests in the same equipment. PMSI priority applies even if the purchase‑money lender knows that a conflicting security interest has been created and/or that the holder of the conflicting security interest has filed a financing statement covering the equipment.
- Obtaining PMSI priority in equipment. The steps required for a lender to obtain PMSI priority in equipment are fairly simple: (a) the proceeds of the loan made by the lender must be used by the borrower to acquire rights in or use of the equipment, (b) the lender must obtain a security interest in the equipment that secures payment of the loan, and (c) the lender’s security interest must be perfected within 20 days after the borrower receives possession of the equipment.
- Regarding the first step, the purchase-money lender can ensure that the loan proceeds did, in fact, enable the borrower to acquire rights in or use of the equipment by disbursing the loan proceeds directly to the vendor of the equipment. As for the third step, in most cases, the lender will perfect its security interest in equipment by properly filing a financing statement on form UCC-1. If the equipment is or will be attached to real property in such a manner that it is or becomes a “fixture”, a local UCC fixture filing may be required. Security interests in certain types of equipment, such as titled vehicles, cannot be perfected solely by filing a financing statement.
- For PMSI priority in equipment, there is no requirement that notice of the purchase‑money lender’s security interest must be given to a lender that has already filed a financing statement describing its collateral as “all equipment”, “all assets”, or the like.
- Some cautions. If any of the steps required to obtain purchase-money priority are not followed exactly, the new lender’s security interest in the equipment will be subordinate to existing perfected security interests of other creditors in the same equipment. For that and other reasons, purchase-money lenders should beware of several potential traps:
- Timing of possession. The 20-day perfection period begins to run on the day the borrower receives possession of the equipment. To the extent possible, the lender should require a signed delivery receipt or other objective evidence of delivery.
- Compliance with the 20-day requirement may become problematic if it is not clear when the borrower received possession of the equipment. For example, the contract of sale may require the vendor to assemble or test the equipment on the borrower’s premises before the borrower is deemed to have accepted the equipment. Or, the vendor may deliver the equipment in stages over a period longer than 20 days, or some material component of the equipment may be delayed in transit more than 20 days after the other components are delivered. Difficulties also can arise in cases where the borrower has delayed applying for the purchase‑money loan and the lender is unable to complete the processing and funding of the loan and the filing of the financing statement or other means of perfection before the 20‑day period expires.
- Lending against already-purchased equipment. Priority issues may arise where the borrower pays the purchase price using other resources and then wants to obtain a loan to finance the purchase price within 20 days after receiving the equipment. As noted above, the lender will obtain PMSI priority only to the extent the proceeds of the lender’s loan enable the borrower to acquire rights in or the use of the equipment.
- Conflicts with other PMSI creditors. If the purchase-money lender will be financing only a part of the purchase price of the equipment the borrower is purchasing, it is important that the lender knows how the borrower will pay the remainder of the purchase price. If the vendor of the equipment provides seller-financing to the borrower for the balance of the price, and the vendor takes a security interest in the equipment and perfects the security interest within 20 days after the borrower receives possession of the equipment, the vendor’s security interest will have priority over the security interest of the purchase-money lender. Similarly, if another lender that takes the steps to qualify for PMSI priority makes a loan to the borrower to finance the balance of the purchase price, the security interest of the lender that filed its financing statement first will have priority in the purchased equipment. If the other lender that makes the loan or advance to finance the balance of the purchase price is the borrower’s existing lender with a perfected security interest in the borrower’s after-acquired equipment, that other lender usually will have priority because almost invariably it will have filed its financing statement first.
- Violations of borrower’s agreements with existing lender. Borrowing the purchase-money loan and/or granting the PMSI to the purchase‑money lender may cause the borrower to violate the terms of the borrower’s agreements with an existing lender, thereby giving the existing lender the right cease making advances and/or to accelerate the borrower’s obligations to it and to foreclose on its collateral. These provisions in the borrower’s agreements may take the form of limitations on the borrower’s incurring additional debt, granting liens or security interests to any party other than the existing lender, or incurring purchase‑money obligations in excess of a prescribed dollar amount. If the existing lender were to accelerate and foreclose on its collateral because of a breach of these covenants by the borrower, the purchase‑money lender may be put at risk of non‑payment of its purchase‑money loan, leaving it to resort solely to collateral in which it has purchase‑money priority. These and similar issues are often resolved by obtaining a consent and waiver from the existing lender before the purchase-money loan is made.
Conclusion. The rules governing PMSI priority in equipment provide an opportunity for a lender to establish a secured lending arrangement with a new customer as borrower, even if the borrower has an existing arrangement with another lender that has a perfected security interest in all of the borrower’s personal property. To establish its “superpriority” position, however, a purchase-money lender must carefully comply with the Article 9 requirements for taking PMSI priority in equipment. The lender also should evaluate the relevant facts and circumstances before committing to or funding the loan, so that it may best protect itself against problems that can arise from competing interests of vendors and lenders to the borrower.
Republished with permission. This article, "Using UCC Purchase-Money Priority to Grow C&I Loans" was published in the January/February 2018 edition of the Alabama Bankers Association's Board Briefs, Vol. 3, No. 1.