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Using UCC Liens in Equipment Financing and Leasing

Using UCC Liens in Equipment Financing and Leasing

Equipment financing and leasing are common ways for businesses to obtain necessary equipment without large upfront costs. The deals involve complex legal issues, including how the equipment serves as collateral for the financing. Understanding these issues is key for all parties – the lessees/borrowers, lessors/lenders, and even third parties that might have an interest in the equipment. This article provides a helpful overview of using Uniform Commercial Code (UCC) liens in equipment finance and lease transactions.

What is a UCC Lien?

A UCC lien is a legal claim on equipment established under the Uniform Commercial Code (UCC) . The UCC is a set of state laws governing commercial transactions, including secured loans and sales of assets.When a lender finances equipment, it usually takes a UCC lien as collateral. This gives the lender a claim on the equipment if the borrower defaults. The lien is established by filing a UCC financing statement with the state.UCC liens are extremely common in equipment finance. Lessors also use them in true lease transactions. The lien gives the lessor priority to take possession of the equipment if the lessee defaults.

Why UCC Liens Matter in Equipment Deals

UCC liens serve several key functions in equipment finance and leasing:

• Collateral for lenders – The UCC lien gives lenders a specific claim on the equipment if the borrower defaults. This allows financing deals that might otherwise be too risky.
• Priority interests – Properly perfected UCC liens establish priority over other creditors. This protects the lender if the borrower defaults or goes bankrupt.
• True lease protections – In true leases, lessors use UCC liens to establish a claim in case of lessee default or bankruptcy. This helps true leases qualify as such under tax laws.
• Notice to third parties – By filing UCC statements, lenders/lessors put third parties on notice of their claim to the equipment. This prevents later creditors from taking higher priority.

So in short, UCC liens are critical for lenders and lessors to manage risk. They give much needed protections in case deals go bad.

Key Factors in UCC Lien Use

Several key factors come into play with UCC liens in equipment finance and leasing:

Proper Filing Procedures

To obtain priority, lenders/lessors must properly file an initial UCC statement and continuation statements. The filings must use the correct legal and business names for the borrower/lessee. Likewise, the collateral description must be accurate and complete. Sloppy filings risk losing priority of the lien.

Purchase-Money Status

With some priority rules, it helps if the UCC lien has “purchase-money” status. This requires the lender to advance funds specifically for acquiring the equipment collateral. Proper documentation and timing is essential to obtain purchase-money status.

Borrower/Lessee Creditworthiness

The borrower’s/lessee’s credit affects how lenders approach UCC liens. Weaker credits may lead a lender to take more equipment collateral. The lender may also impose stricter terms around maintaining lien priority and prohibiting liens.

Nature of the Equipment

UCC rules vary for different equipment types. Special priority rules apply to vehicles, for example. Some gear may not qualify as UCC collateral at all. So the nature of the equipment affects how lenders utilize UCC liens.

Jurisdiction-Specific Factors

The UCC allows for state-specific variations. So equipment finance UCC practices can vary across jurisdictions. Parties should understand any unique lien rules and practices in states where collateral is located.

Key UCC Lien Protections

UCC liens provide lessors and lenders several meaningful protections:Priority claim on collateral – Assuming proper filing, the UCC lienholder has priority access to repossess and liquidate the equipment upon lessee/borrower default. This protects the finance provider’s interests.Right of repossession – If a lessee/borrower defaults or goes bankrupt, the UCC lien gives a contractual right for the finance provider to repossess its equipment collateral. This helps avoid lengthy legal battles.Critical in bankruptcy – A properly perfected UCC lien survives borrower/lessee bankruptcy and maintains priority creditor status. This helps avoid situations where equipment gets tied up in court proceedings.Enforceability – UCC liens allow lessors/lenders to foreclose and enforce their claim on collateral through streamlined legal processes. This ability to directly enforce one’s rights is a key appeal of UCC liens.Notice protection – Because UCC statements are publicly filed records, the liens serve legal notice protecting lessors/lenders from third party claims on their collateral. This helps avoid messy disputes over rights to the same equipment.So in summary, UCC liens provide robust and well-defined protections that lessors/lenders rely on. Without these protections, equipment finance arrangements would be far less secure.

Using UCC Liens in True Leases

UCC liens play a special role enabling true lease transactions. Under tax laws, a contract must meet certain tests to qualify as a true lease. One key factor is that the lessor holds a meaningful residual interest in the equipment. UCC liens help true leases satisfy this requirement.By taking a UCC lien on the equipment, the lessor establishes collateral rights similar to those held in a secured loan. This shows the lessor has not fully “disposed” of the equipment to the lessee. Including UCC lien rights also helps justify the lessor’s right to repossess equipment upon lessee default.In this way, properly structured UCC liens help enable true lease treatment. Without them, equipment contracts might fail the key tax law tests to be true leases.

UCC Lien Pitfalls to Avoid

While invaluable, UCC liens also come with pitfalls equipment financers must avoid:Lien subordination – Borrowers may sometimes request lenders to subordinate their UCC lien priority under an intercreditor agreement. This adds risk and weakens the lender’s position.Missed filings – Lenders occasionally miss initial filings or continuation statements. This could negate perfection and priority of the lien—a disastrous outcome.Insufficient collateral – If major equipment components get excluded from the collateral description, it severely erodes the protection a UCC lien would otherwise provide.Borrower name errors – Seemingly minor name errors on UCC filings can invalidate a lien’s perfection. Again, this could upend a lender’s whole collateral position.Bankruptcy cramdowns – In rare cases, courts may “cramdown” properly perfected liens in bankruptcy. This legally devalues the collateral claim below loan balance owed.Buyer in ordinary course – If borrowers sell inventory-type equipment to buyers in the normal course of business, it may extinguish lenders’ UCC lien. This causes lenders to lose priority rights.So lenders must pay close attention on UCC lien details and priority swaps. Any missteps could negate expected protections.

Key UCC Lien Defenses

While powerful, UCC liens are still subject to certain debtor defenses. Borrowers may legally challenge lenders on issues like:

• Unconscionability – If terms are fundamentally unfair, borrowers can argue the lien is invalid.
• Improper filing – Technical filing defects may void a lien’s perfection.
• Lien priority – Borrowers can seek to invalidate junior liens that violate intercreditor agreements.
• Collateral disputes – Questions around what equipment was pledged as collateral could affect enforceability.
• Consumer goods – Special UCC rules protect certain household goods from creditor claims.

So borrowers do have meaningful grounds to contest UCC lien rights in some cases. Lenders must structure terms reasonably and fulfill all technical requirements.

Best Practices for UCC Lien Use

Given the importance and complexity of UCC liens, finance providers should follow best practices like:

• File statements correctly at outset and maintain proper continuations.
• Clearly identify all equipment/collateral and serial numbers upfront.
• Strive for purchase-money status whenever possible.
• Add requirements prohibiting additional liens in loan/lease documents.
• Carefully assess risks before subordinating lien priority under intercreditor deals.
• Review and understand any relevant jurisdiction-specific UCC rules.
• Watch out for borrower equipment sales that could violate lender’s expectations.
• Avoid over-reliance on UCC lien protections without also evaluating borrower credit risk holistically.

Proactively addressing these factors will help lessors and lenders avoid issues. Following best practices makes UCC liens an extremely useful risk mitigation tool.

Conclusion

UCC liens provide invaluable protections for equipment lessors and lenders. They establish enforceable collateral rights in financed equipment. However, parties must take care to properly structure, file and maintain these liens. Lapses can completely negate expected protections. So all sides should appreciate the power of UCC liens while also respecting their technical demands. With the right diligence by lessors/lenders, and adequate representations by lessees/borrowers, UCC liens will strengthen equipment finance transactions considerably.