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The 2001 amendments to the Uniform Commercial Code (UCC) attempted to dramatically simplify the process of perfecting a security interest in personal property. For most types of personal property, such as accounts receivable, equipment, inventory and raw materials, perfection is accomplished by filing a UCC-1 financing statement with the secretary of state’s office in the state in which the borrower is incorporated. The laws of states concerning perfecting a lien based on a claim obtained by judgment may interfere with the simplicity sought by the amendments to the UCC-of requiring a filing only in the state of a borrower’s incorporation. Attorneys representing lenders and judgment creditors should beware. Following the plain language of the UCC may leave a lender subject to a lien of a judgment creditor that the lender did not know existed. On the other hand, following the plain language of state laws concerning perfecting a judgment lien on personal property may leave judgment creditors with no lien at all. Most medium to large businesses, public and private, leverage the value of their assets by borrowing money. An “asset-based” lender is one that determines how much it is willing to lend to a borrower depending upon the value of the borrower’s assets. For example, it is common in the manufacturing sector for lenders to agree to lend to manufacturer-borrowers up to 80% of the face amount of accounts receivable that are less than 75 days old, and 25% to 50% of the liquidation value of equipment, inventory and raw materials. Looking beyond borrower’s state of incorporation Before an asset-based lender agrees to advance funds to a borrower, it needs to determine what other entities or individuals, if any, have lien rights in the borrower’s assets. Before the 2001 UCC amendments, to know whether any entities or individuals alleged perfected secured claims against the potential borrower, lenders had to get reports from the secretary of state’s offices in any state in which the borrower had assets. The amendments were intended to allow lenders to look solely to the secretary of state’s office in the borrower’s state of incorporation. For myriad reasons, most businesses are incorporated in Delaware or Nevada. Suppose there is a potential borrower that has administrative offices in Illinois, conducts all of its manufacturing operations in California and is incorporated in Delaware. A potential lender to this company would, prior to making any loans, review a report of all the filings made against the borrower in the office of the secretary of state of Delaware. According to the UCC, after 2001, UCC-1 financing statements filed in either Illinois or California would be meaningless. Only those filings made with the Delaware secretary of state would be valid as against other creditors claiming to have a security interest in the borrower’s assets. If no filing by creditors were revealed on such report, the lender would enter into a loan and security agreement with the borrower and file a UCC-1 financing statement in Delaware prior to making the loan. The lender would believe that by being the first to file a UCC-1 financing statement against the borrower’s assets, it would obtain a first-position perfected security interest in the borrower’s assets. A judgment creditor may already have an interest As set forth below, this may not be true because there may be a judgment creditor of the borrower that has a first-position perfected interest in the borrower’s assets that serve as the lender’s collateral because of the filing of a document with the California secretary of state purporting to notify all of the borrower’s creditors of the judgment. Suppose that a creditor of the borrower brings a lawsuit against the borrower in California and obtains a judgment against the borrower. Under California law, a judgment creditor can create a lien on the borrower’s personal property assets by filing a document entitled “Notice of Judgment Lien” to which the judgment is attached. Thus if a lender were to search the California secretary of state’s records for any filings against the borrower, the report generated would reflect UCC-1 financing statements and notices of judgment liens. The California statute at issue is California Code of Civil Procedure � 697.530. It reads in part: “A judgment lien on personal property is a lien on all interest in the following personal property that are subject to enforcement of the money judgment against the judgment creditor . . . if a security interest in the property could be perfected under the Commercial Code by filing a financing statement at that time with the Secretary of State: Accounts receivable[;] . . . Equipment[; and] . . . Inventory.” In almost every state, including Delaware and Nevada, a security interest in the three types of personal property listed above can be perfected by the filing of a financing statement with the secretary of state. The problem with California’s statute and that of other states is that the statutes addressing perfecting a judgment lien do not clearly mesh with the laws addressing consensual liens granted under the UCC. There is no case law addressing the apparent inconsistency in the law in California. California is important because its courts can be quite plaintiff-friendly, and most medium to large corporations either have operations in or are otherwise subject to being sued in California. Fairness does not dictate a result for the lender or the judgment creditor. From the lender’s perspective, the 2001 UCC amendments clearly intended to allow lenders to look solely to the files of the secretary of state in the state of the borrower’s incorporation. To require lenders to search the secretary of state’s offices in all states where the borrower may lawfully be sued would completely defeat that purpose. However, from the judgment creditor’s perspective, fairness may dictate that a filing in the state where the judgment is obtained should control. Even if the judgment creditor were to know about the ambiguity of the law and desired to file a notice of judgment lien in Delaware, the judgment would first have to be domesticated in Delaware. Domestication requires the judgment creditor to begin an action in Delaware and notify the judgment debtor of the filing of the action; the judgment debtor then is given a chance to challenge the legitimacy of the judgment. While there are very few challenges that a judgment debtor could successfully make to the legitimacy of the judgment because most states in the United States uphold and honor the judgments given in other states, the process can take weeks. Only after the judgment is domesticated will the state of domestication recognize the judgment and allow a notice of judgment lien to be filed with the secretary of state’s office. During the weeks it takes to domesticate the judgment, the judgment debtor, aware of the existing judgment, can borrow money and encumber its assets to the detriment of the judgment creditor. While a judgment creditor may be able to get orders prohibiting the judgment debtor from encumbering its assets, such an order does not affect the priority-of-liens issue. It seems unfair that a creditor that obtains a judgment against a borrower whose entire operations are in California cannot obtain a perfected interest in the judgment debtor’s personal property assets until it domesticates the judgment in Delaware and thereafter files a notice of judicial lien. On the other hand, it also does not seem fair that a lender that files a UCC-1 financing statement with the secretary of state for the borrower’s state of incorporation without knowledge of the existence of the judgment should have lien rights inferior to the judgment holder. The difficulty in analyzing the issue is that the legislative history of California Code of Civil Procedure � 697.530 focuses on the type of property rather than the location of the judgment debtor. Further, there were no corollary amendments to California’s enforcement-of-judgments provisions at the time the 2001 UCC amendments were made. These facts support the judgment creditor’s position. On the other hand, it is a logical argument that the “Secretary of State” referred to in the statute is the California secretary of state. The language is not “any Secretary of State” it is “the” secretary of state, implying a specific secretary of state, which could only be California. A creditor cannot perfect a lien on assets of a company incorporated in Delaware by filing a UCC-1 financial statement with the California secretary of state even if the company’s business is entirely conducted in California. These facts support the asset-based lender’s position. It appears that the California Legislature did not consider this issue at the time � 697.530 was enacted, and the crux of the issue is whether the courts will give the statute a different meaning in light of the 2001 UCC amendments. Steps to take to avoid malpractice At present, a transaction attorney representing a lender needs to inform the client of the ambiguity in the law and, depending on the size of the transaction, should perform a search of all the secretary of state offices. At a minimum, counsel should order a search of the California secretary of state’s office and any other secretary of state’s office in states where the company has assets. A litigator assisting a judgment creditor to collect the judgment must also take care. The litigator should recommend domestication of the judgment in the judgment debtor’s state of incorporation as quickly as possible. The litigator should also recommend the filing of a notice of judgment lien in the state in which the judgment was obtained. Craig M. Rankin is a partner at Los Angeles-based Levene, Neale, Bender, Rankin & Brill, which specializes exclusively in matters of bankruptcy, insolvency and business reorganization.

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