Why should I care and what should I know?
Whether you’re a small business owner who’s hoping to expand, or just getting started; or, as often times in today’s economy, in need of some extra capital to stay afloat, you’re more than likely going to come into contact with a UCC Form-1 filing.
What is the UCC?
The UCC, or Uniform Commercial Code, is a uniform set of laws established to regulate sales of personal property and other business transactions. It contains legal rules and regulations governing commercial or business dealings and transactions. Each state has adopted sections of the code as state law, including California. In this discussion, we focus on the UCC-1 Financial Statement filing or lien as it may affect you and your business transactions. For additional information on which of the UCC articles that have been adopted in California, click here.
UCC-1 Financial Statement
According to the California Secretary of State’s website, a UCC-1 filing is:
a financial statement … filed to perfect a security interest in named collateral and establishes priority in case of debtor default or bankruptcy…
Ok, so what does that mean? Simply put, it is a method for a lender to secure personal property as collateral on a loan to ensure they are repaid. Should the borrower default, the lender has the right to seize and sell the encumbered assets to satisfy the debt.
In contrast, it is important to note that real property is typically secured by a lien on the property, which is filed with the county recorder of deeds office where the property is located, not with the state. However, when you secure a loan using personal property, which is basically anything except real property (real estate), the lender will file a UCC-1 Filing Statement giving them a right to collect on the loan amount by repossessing or seizing your personal property or their liquidated assets. It also provides notice to future potential creditors that the assets have been encumbered, giving priority to the first creditor to file a lien against the asset in the event the borrower defaults or files for bankruptcy protection.
There are numerous ways that these filings can come into play. For example, if you purchase on credit an expensive piece of manufacturing equipment or a tangible asset specific to your business needs, the seller can (and most likely will) file a UCC- 1 Form. In this case, if you default on your payment arrangements the seller can simply come and take back the product. Or, perhaps you’ve entered into a security agreement on a note to purchase business assets. In that case, the lender can either a) list specific property that amounts to the value of the loan; or b) include a blanket lien whereby the lender may seize any and all of your business assets to the extent of your liability on the note. Assuming the security agreement permits foreclosure without obtaining a judgment against the borrower, the lender may unilaterally take possession of the assets, sometimes without notice, and sell them to satisfy the amount due, which usually includes the costs of foreclosure.
UCC-1 Filings and Your Business Credit Rating
If you have one or more UCC-1 liens in connection with your business assets, it is critical that you actively keep track of how they show on your credit report. If you satisfy a lien, the UCC-1 is NOT AUTOMATICALLY REMOVED from your credit report. Let’s say a lien is reported on your business credit report on a specific piece of equipment. You made all the required payments pursuant to your loan agreement and the lender stopped sending you invoices. It is not safe to assume, under these circumstances, that the UCC lien has been extinguished; you still have to make sure the lender files a Form-3 that effectively removes the original lien.
Failing to ensure UCC-1 liens are removed will negatively affect your ability to get additional or future loans, financing, etc. If a prospective lender or purchaser of your business assets runs a check on your business and sees outstanding UCC-1 filings, that can directly affect the image and attractiveness of your business, and your business credit rating. Ultimately, the more encumbrances there are on your business assets, the less attractive you become as a borrower.
Be aware, also, that you cannot typically use personal property to secure a loan if a lien has already been filed against it, unless the lender expressly agrees to take second priority, which usually results in a much higher interest rate. This is another important reason to make sure that you not only keep close track of any active UCC-1 filings, but when one has been satisfied, you ensure the original lender files the proper documents to release the lien, which will then be reflected on your business credit report.
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