In the commercial practice, sales on credit or installment payments are very frequent, and constitute a form of financing that facilitates commercial exchanges. Sale contracts or general conditions of sale often contain clauses providing that the goods sold will remain the property of the seller until paid in full. Sellers should be aware that similar provisions do not provide any protection against other secured creditors unless additional steps described below are taken. Banks extending credit usually obtain a blanket security interest in all debtor’s assets, including inventory, which conflicts with the seller’s retained title in the goods sold. Unless certain steps are taken, the bank will have priority over the retention of title and will be able to take possession of the goods in the inventory, including the goods owned by the supplier, even if the contract clearly provides that such goods are owned by seller. Moreover, in case of bankruptcy the trustee in bankruptcy would claim those goods and seller would be relegated to the status of an unsecured creditor for payment of the unpaid price.
Commercial transactions are governed by the Uniform Commercial Code (UCC), which has been adopted, with small variations, by 49 out of 50 states (Louisiana has a civil law system and has not adopted the Uniform Commercial Code in its entirety). Under Article 9 of the UCC, a complex system of filings ensures that a security interests on goods purchased (“purchase money security interest”) be “perfected” (i.e., enforceable) with priority over the interests of other secured creditors even if such creditors protected their right by filing before the seller.
According to the UCC, to ensure that the security interest in the goods sold in a sale on credit (a “purchase money security interest”) be “perfected” against the rights of third parties, several steps must be taken:
· The parties must have entered into an agreement that creates the security interest in the goods. In practice, the written sales contract must expressly grant such a security interest – and the clause under which the seller retains title to the goods may not be sufficient.
· If the goods constitute inventory for the buyer, the seller must search the appropriate UCC records to identify possible conflicting security interests filed against the buyer. A search can be run at the Secretary of State of the state of incorporation of the buyer to determine if any creditor has a security interest in assets of the debtor that would conflict with the purchase money security interest of the seller, such as for example the security interest of a bank in “all assets” of the debtor, present and future, including inventory.
·If applicable, the seller must notify in writing (preferably by certified mail, return receipt) all creditors that have a conflicting interest. The holder of the conflicting security interest must receive the notice before the form below is filed. Note that the goods sold are not inventory (for example, sale of equipment to be used by the buyer), no such search and no such notice are necessary.
·In any case, the seller files a form (“UCC-1 financing statement”) with the Secretary of State in the state of incorporation of the buyer. The form includes the names of the parties, address, legal form, a description of the collateral, and the nature of the transaction. Note that the filing is ineffective if lodged with the wrong Secretary of State, e.g. in the state where goods are located or where the buyer has its warehouse or headquarters, if different from the state of incorporation. It can also be ineffective if it contains errors as to the name of the debtor, its legal form, and address. It is therefore necessary to obtain from the buyer a specific representation as to the correct name, the type of corporate entity and the State in which the entity is established.
· The goods subject to the security interest (“collateral”) must be sufficiently identified. In general it is advisable to extend the security interest to the money generated by the sale of the asset or insurance proceeds (‘proceeds”).
· The filing must be completed before delivery or shipment of the goods. A security interest in goods other than inventory can be filed within 20 days from delivery.
· The filing remains in effect for 5 years and must be renewed in the last six months before the expiry date by filing a similar form (UCC-3 Continuation Statement).
· After filing, the UCC-1 must be properly managed in order to maintain its effectiveness. If the buyer’s name or legal form changes, a filing reflecting such change must be made within 4 months, otherwise the filing becomes ineffective with regard to goods delivered after the change of name; similarly, if the debtor reincorporates in another State, a new UCC-1 must be filed in the new State.
The regime of UCC-1 filing is a necessary tool to ensure that the right to goods in the possession of the other party is perfected against third parties. For example, the right to leased property, bailments, or consignments, should be protected by filing a UCC-1 form similarly to what was described above, to ensure enforceability against third parties. Relying on a contract clause to retain title to the sold property without carefully following the steps described above would give a false sense of security to a seller, and no protection.
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Requests for information or insights on the issue discussed in this article may be addressed to the author at majda.barazzutti@vallalaw.com or mario.riva@vallalaw.com. This article is for information purposes only and does not constitute legal advice. The information contained herein may be outdated or incomplete, and shall in no way be taken as an indication of future results. The transmission of this article is not intended to create, nor does its receipt constitute, an attorney-client relationship between preparer and reader. You should not act on the information contained in this article without first seeking the advice of an attorney