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13 Jan 24

Removing Invalid UCC Liens Related to Business Loan Payoffs

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Last Updated on: 15th January 2024, 10:51 am

Navigating the Pecking Order of UCC Lien Priority

Understanding lien priority under the Uniform Commercial Code (UCC) can be tricky. There’s a whole pecking order that determines who gets paid first if a debtor defaults. This article will walk through the basics so you can wrap your head around it.

First Things First – What is a Lien?

A lien is a legal right granted to a creditor to sell property belonging to a debtor in order to satisfy a debt. Let’s say Debbie takes out a loan from First Bank to buy some equipment for her bakery. The loan agreement gives First Bank a lien on that equipment. If Debbie stops making payments, First Bank can seize the equipment and sell it to get their money back.

The Players

OK, with that basic understanding of what a lien is, let’s talk about the key parties involved:

  • Debtor – The person or company that owes money
  • Secured Creditor – A lender with a lien on the debtor’s property
  • Unsecured Creditor – A lender without a lien

Generally speaking, secured creditors will get paid before unsecured creditors in the event of default. But even among secured lenders, there is an order of priority.

The Pecking Order

Here’s a quick breakdown of how the UCC determines priority among conflicting security interests:

  1. Purchase-money security interests
  2. Previously perfected security interests
  3. First to file or perfect

Now let me unpack each one of those…

#1: Purchase-Money Security Interests

A purchase-money security interest (PMSI) is a type of lien that helps the debtor acquire the collateral in the first place. For example, if First Bank lends Debbie money specifically to buy that bakery equipment – that would be a PMSI. PMSIs get first dibs because without that loan, the debtor wouldn’t have the asset at all.

#2. Previously Perfected Security Interests

Assuming there’s no PMSI in play, previously perfected security interests come next. A perfected security interest simply means the creditor took all required steps to validate the lien under the UCC. This usually means properly filing a UCC financing statement. If First Bank had an existing lien on Debbie’s equipment going into her new loan, First Bank would likely get paid before the new lender.

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#3. First to File or Perfect

If there’s no PMSI and no previously perfected security interests, then priority goes to whoever perfected their lien first. That brings us back to the importance of filing that UCC statement. It’s a race to the filing office!

What Can Mess Up Priority?

There are a couple situations that can undermine a secured creditor’s priority:

  • Subordination agreement – A creditor with lien priority rights may sign an agreement allowing another creditor to move up the pecking order.
  • Buyers in ordinary course – If a debtor sells secured collateral to an innocent buyer, the buyer may take ownership free of the lien.

As you can see, the UCC rules around competing liens can get hairy. If you have any questions about lien priority for a deal you’re structuring, be sure to get help from legal counsel.

The Takeaway

While UCC lien priority may seem complex at first glance, just remember the pecking order:

  1. Purchase-money security interests
  2. Previously perfected liens
  3. First to file or perfect

Armed with that framework, you can start wrapping your head around who might get paid first if things go south with a debtor.

References:

UCC §9-103 – Purchase-money security interest; application of payments; burden of establishing.

UCC §9-322 – Priorities among conflicting security interests in and agricultural liens on same collateral.

UCC §9-317 – Interests that take priority over or take free of security interest or agricultural lien.