Without question, the best business and legal solutions are the ones that are not generated in the courtroom; instead, they can be found in the practical decisions that companies make every day. The following time- and money-saving tips offer a few examples of how smart creditors can better protect their collateral.
Priority Liens: Perfect Your Security Interest Ahead of Time
In the complex world of commercial lending, the most prudent creditors always make sure they will have a priority lien on the collateral used to secure a loan before actually funding the loan. There is a time gap, however, between when the loan closes and the date the lien is actually recorded. As a result, we have too often seen one creditor surprised to learn that someone else jumped to the front of the priority line during that gap.
When collateral takes the form of real property, title insurance offers creditors the assurance of priority. But where is the protection for personal property? The answer lies within the Uniform Commercial Code (UCC), a set of laws adopted by all 50 states to regulate commercial transactions. The UCC allows a secured creditor to file a financing statement prior to funding a loan as a means of establishing the creditor’s outstanding security interest in the borrower’s personal property and perfecting its lien against that property. Because creditors must obtain authorization from their borrowers to pre-file a financing statement, such permission should be incorporated into all commitment letters. In the end, this simple solution will go a long way towards protecting a creditor from so-called claim jumpers.
Keep It or Grab It: The Importance of Possession
Most people have heard the saying “possession is nine-tenths of the law.” In the context of commercial lending, there is certainly great truth to that. For creditors, possession of money or collateral is key to securing your position or applying pressure to reach an out-of-court resolution when a borrower is in default.
First, consider the “keep it” scenario. Let’s say a borrower owes money to a bank where the same borrower also has money on deposit. Whenever there is a doubt of repayment, the creditor should attempt to keep the money by invoking its setoff rights, which allow a bank to seize a borrower’s account balance held at that bank if a debt is in or near default. Although many creditors seem reluctant to invoke this common-sense remedy, it is appropriate (and wise) to place an administrative hold on the borrower’s funds until the rights of the parties can be determined. This is true even in the face of a filed bankruptcy petition.
Now let’s look at the “grab it” scenario. In the case of personal property, it is best to take possession of that collateral as quickly as possible. Sometimes a creditor can do so without the burden of costly and time-consuming court processes. When faced with a court system that is backlogged with foreclosure suits, creditors that have taken personal property as security for their loans have a distinct advantage. In fact, the UCC allows a secured creditor, after an event of default, to simply take back its collateral, not unlike a repo man who comes to tow your car away in the middle of the night. Be careful, though. When repossessing collateral, creditors must not do anything to breach the peace, including unauthorized entry into buildings. So, how would a creditor go about retrieving property without trespassing? One solution is for the borrower to incorporate an irrevocable, unconditional right of entry into the loan at its inception. Sometimes this language is already incorporated into standard security instruments, but oftentimes the necessary language is omitted or insufficient.
For creditors faced with the prospect of a borrower in default, these tips will help you achieve better results in a more timely fashion and, more often than not, at significantly less expense.
This document is intended for informational purposes only and is not legal advice or a substitute for consultation with a licensed legal professional in a particular case or circumstance.
Kurt M. Carlson | Creditors’ Rights, Insolvency & Bankruptcy Litigation & Resolution
Kurt’s practice concentrates on representing creditors, assignees and businesses of all sizes in a variety of ways, including complex business litigation, workouts, insolvency proceedings, bankruptcy reorganization cases and complex settlement negotiations. Kurt has extensive experience in a broad range of quasi-business and legal issues companies must address. If you need assistance with a related matter, contact Kurt.
Martin J. Wasserman | Commercial Litigation and Bankruptcy
Martin advises clients in both Illinois and Wisconsin on an array of commercial litigation and bankruptcy matters, including loan workouts, issues, receiverships and commercial foreclosure matters. Martin has extensive experience in all aspects of litigation in both federal and state courts, complex workouts and a growing appellate practice. If you need assistance with a related matter, contact Martin.