In last month’s digest, we focused on the fact that there are certain items and types of collateral for which an “all assets” UCC filing will not perfect a lien. This month, we will help you understand the ins- and-outs of perfection of insurance proceeds under UCC Article 9.
Article 9 governs perfection of a security interest in personal property interests as opposed to interests in real property and other types of special types of collateral. Security interests in certain types of personal property collateral may be perfected differently. Some interests are perfected by the filing of a financing statement with the appropriate filing office while some others are perfected through possession or control or notation on a document.
Though UCC Article 9 generally does not apply to a transfer of an interest or claim in or under a policy of insurance other than the assignment of a health care receivable, there are exceptions to the rule of which an astute lender should be aware.[1]
“Proceeds”
UCC Article 9-102 defines “Proceeds” to include the value of the collateral and to the extent payable to the borrower or secured party, any insurance payable by reason of loss or non-conformity of defects or infringement of rights in, or damage to, the collateral. The term “Proceeds” includes money, checks, deposit accounts and other “cash proceeds”. A secured party’s rights also attaches to identifiable proceeds of collateral pursuant to UCC Article 9-315.
Why Require A Borrower Insure?
Lenders generally insist that borrowers obtain insurance policies to protect a lender’s interest in the borrower’s personal property. The protection is both for the benefit of the borrower and the lender. By insuring and protecting the borrower’s interest in the borrower’s personal property, the property the borrower can offer as collateral is protected, thus providing more security to a lender and an increased possibility that the lender will lend under more favorable terms. Lenders, in turn, view this insurance as part of their collateral package that will assist them in the event of a casualty event or some other action.
Perfection
If a piece of personal property is subject to a security interest, perfection occurs through listing the lender as a Loss Payee or Additional Insured as appropriate under the insurance policy. This is acknowledged by the insurance company by issuance of the policy binder. The interests as Loss Payee or Additional Insured are separate and distinct. If the only interest the lender has is in the collateral itself it is appropriate to only list the interest as being that of a Loss Payee. Once this is confirmed by the insurance company under the binder upon any catastrophic event, the proceeds of the policy will be paid directly to the lender up to the value of the personal property.
Pursuant to Article 9-315 the secured party is automatically perfected in proceeds within its security interest. However, it is prudent to note that the term “proceeds of any of the foregoing” should be included in any UCC financing statement in order to protect the lender if any payment is made other than directly to the lender. If the proceeds are not directly payable by the insurer to the secured party, once the funds go into a debtor’s accounts the secured party will likely have a problem tracking the proceeds as being identifiable to its interests as opposed to the interests of other parties.
Can An Insurance Policy Be Collateral?
Questions also arise as to whether an actual policy of insurance can be taken as collateral. In Illinois, courts have held that life insurance policies can be used as collateral through an assignment of the party’s rights and privileges under the policy.
And insurance policies vary between insurers. Therefore, a policy needs to be reviewed to determine whether it permits assignment and the method for doing so. In absence of any specific language to the contrary, courts have held that any language in the policy that demonstrates an ability to transfer some interest is sufficient to allow a transfer of the interests under the policy. The normal method of perfection on life insurance policies is through an assignment of a collateral interest in the policy which is signed both by the borrower and acknowledged by the insurance company. The policy should be specifically identified as opposed to language such as “any policy the insured has with the insured.” Also, the acknowledgment of the assignment by the insurance company should eliminate the possibility of any proceeds being paid to parties other than the secured party, and should avoid any commingling issues.
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[1] There are other interests in insurance policies which are governed by UCC Article 2A. However, those are beyond the scope of this article.
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.
