Expert’s Corner: Lender Loses Due to Perfection Procrastination

October 1, 2013

By Paul Hodnefield, Esq.

As a general rule, there is no time limit for a secured party to perfect its security interest under UCC Article 9. The secured party, however, faces the loss of priority or worse if it fails to perfect promptly, especially if the debtor later files for bankruptcy. A secured party recently suffered the consequences of delayed perfection in the case of In re: LDB Media, LLC, 2013 Bankr. LEXIS 3785 (Bankr. M.D. Fla. Sept. 12, 2013).

LDB Media, LLC (the “Debtor”) operated a 24-hour news station in Florida. In 2009, the Debtor took out a $400,000 loan from a division of NYT Management Services (“NYT”). The loan was secured by certain assets used in the operation of the Debtor’s cable channel, including a number of vehicles. NYT filed a UCC-1 financing statement to perfect its security interest.

NYT assigned the note and its rights under the security agreement to Gravitas Leasing (“Gravitas”). Later, Gravitas and the Debtor entered into a consolidated and renewed promissory note. The renewed note was again secured by the assets used to operate the Debtor’s cable channel.

Gravitas filed a financing statement in 2010 that described the collateral as “All that personal property, equipment and vehicles described on ‘Exhibit B’ attached hereto and made a part hereof.” Exhibit B provided a list of collateral as it appeared in the security agreement, including nine vehicles and a variety of specific equipment.

While the Debtor had purchased the vehicles in 2009, it had not yet transferred the titles into its own name. Likewise, Gravitas had not yet perfected its liens on those vehicles by having the security interest indicated on the titles.

In 2011, the Debtor defaulted on the obligation. Gravitas sued the Debtor in state court to recover on the note and foreclose its security interest. Gravitas obtained a final summary judgment in January 2012 and scheduled a foreclosure sale. Shortly before the scheduled sale, the vehicle titles were reissued in the Debtor’s name. Gravitas had its liens indicated on the titles at the same time.

Three days before the foreclosure sale, the Debtor filed for bankruptcy. Gravitas submitted a secured claim in the bankruptcy case for $454,425 based on the UCC-1 and judgment. The Debtor, however, objected and began an adversary proceeding to avoid Gravitas’ claim.

The Debtor asserted that Gravitas did not perfect its liens on the vehicles until within 90 days of the bankruptcy filing. According to the Debtor, those liens could be avoided as preferential transfers.

The court quickly disposed of the preference issue. Gravitas did not note its interest on the vehicle titles until sometime during the 90-day preference period. Consequently, perfection of the security interest appeared to be a voidable preference.

Gravitas, however, argued that it should be entitled to an equitable exception to the rule that preferential transfers may be avoided. The basis for this proposed exception was that Gravitas could not note its security interest on the titles until within 90 days before the bankruptcy because the Debtor was not listed on the titles until that time. Once the Debtor had the titles reissued in its own name, Gravitas acted promptly to have its security interest added to the title.  In fact, Gravitas noted its interest on the titles within a day after the Debtor had the new titles issued.

The court was not persuaded by Gravitas’ equitable exception argument. Gravitas cited no legal authority for such an exception. Moreover, Gravitas could have insisted on perfecting its security interest at the same time it perfected its security interest in the other collateral. That was almost two years prior to the bankruptcy filing. If it had done so, Gravitas would have discovered that the Debtor had not obtained titles to the vehicles in its own name. At that point, Gravitas could have insisted that the Debtor have the titles reissued in its name so Gravitas could perfect its security interest.

Nothing prevented Gravitas from perfecting its security interest well before the 90-day preference period. Consequently, the court ruled that Gravitas’ perfection of its security interest in the vehicles was avoidable as a preferential transfer under the bankruptcy code.

The important thing to take away from this case is that Article 9, the Bankruptcy Code and the courts are all unforgiving when a secured party fails to perfect its security interest in a timely manner. Any delay by the secured party can easily result in the loss of priority or even render the security interest unenforceable as a voidable preference in bankruptcy. Secured parties, therefore, should make every effort to perfect their security interests at the earliest opportunity.

Paul Hodnefield is Associate General Counsel for Corporation Service Company (CSC) and a frequent speaker/writer on UCC due diligence issues. Please feel free to contact him with questions or comments at phodnefi@cscinfo.com or 800-927-9801, ext. 62375.