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Priority of Claims Under the UCC
By Michael C. Dennis, MBA, CBF

The Uniform Commercial Code (the "UCC") is a group of rules dealing with business transactions that have been adopted by every state. The UCC has created a mechanism to identify which creditor's claim is superior to the other's. Generally speaking, the creditor that properly files the lien first has the superior claim.

In order to record a security interest in the property of the debtor, the creditor has to file a document with a particular State official in the State in which the asset pledged as collateral is located. That document filed is called a financing statement. A financing statement is intended to put other creditors - that may be offered the same asset(s) as collateral in the future - on notice that another creditor has already perfected a security interest in that asset. Any creditor can have the public records examined to determine if prior liens exist.

There are several pitfalls to using financing statements:

    1. The process of perfecting a security interest can be a little different in each State.

    2. Creditors cannot perfect a security interest in inventory after it has already shipped. Therefore, creditors must hold orders until this process is complete if they want to have a perfected security interest in an asset of a debtor company.

    3. Debtors are sometimes reluctant to agree to allow trade creditors to become secured creditors.

    4. Often, the debtor's bank - itself a secured creditor - will not allow the debtor to pledge assets to trade creditors.

Another problem is the fact that a search of the public records may reveal a pre-existing and perfected security interest in the asset pledged as collateral - so it is critical to search the public records carefully before relying strictly on the pledge.

Creditors should also be aware that the requirements for accuracy in filing a financing statement are fairly rigorous. For example, filing a statement listing the Debtor Company as ACD Bread Company would probably not stand up against a challenge from a creditor who recorded a financing statement later, but correctly listed the debtor company name as the AC/DC Bread Company. The second creditor to file would be correct in relying on the fact that no one had perfected a security interest in the assets of AC/DC. Therefore, under the UCC the rights of that second creditor to the assets of the debtor would be superior to those of the first creditor.

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