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Filing the UCC1 Form for Personal Property Liens

April 13, 2006

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One recommended asset protection strategy involves using an operating/holding company business structure. Then, liens are used to secure any extension of credit from the owner or holding company to the operating company.

In this case, the loaned cash or purchased property is backed by your secured lien on either that same property or some other asset owned by the operating company. This structure protects the operating company's assets against the claims of creditors.

Liens against personal property are perfected differently than liens on real property. Here, "personal property" does not mean property owned personally by the owner of the business. Instead, the term refers to all property used inside or outside of a business (with the exception of real property), including equipment, furniture, inventory, etc.

To perfect a lien against personal property used in a business, a Uniform Commercial Code Form 1 (UCC1) must be executed and filed either in the secretary of state's office or the county courthouse, depending on the state.

Once recorded, the UCC1 makes the lien valid and serves as notice that the lien exists. Usually, the first to record a lien takes priority.

Work Smart Article 9 of the Uniform Commercial Code contains rules on types of liens and their priority. Usually, the first lien recorded will take priority. However, there are exceptions: When the operating entity purchases inventory from an outside creditor, on credit, and puts up the inventory as collateral for the purchase (a purchase money security interest), the holding entity that has a perfected non-purchase money security interest in the inventory must give notice of the lien before the purchase, or otherwise the outside creditor's lien will have priority, even though it was not recorded first. In the same situation, if the property is not inventory, the outside creditor will take priority only if he records the lien within ten days after the operating entity takes possession of the purchased property. Two lessons should be learned here: Recording the holding entity's lien immediately will usually protect the owner's interest. If the holding entity purchases inventory on credit, the operating entity should notify the outside creditor, in writing, of the holding entity's lien before the purchasing agreement is signed.

The UCC1 not only can be used to perfect a lien when acquiring assets, but also against existing property, future-acquired property and open accounts (i.e., future debt).

Existing property subject to the lien is specifically listed on the UCC1. The UCC1 also describes the nature of the indebtedness and the lien that has been established.

So-called "floating liens" apply to future-acquired property or future credit. The agreement, which created the lien, between the holding entity (or owner) and the operating entity may state that all future-acquired property of the same class is subject to the same lien. Similarly, the operating entity can establish an "open account" with the holding entity (or owner), whereby any future credit extended by the holding entity (or owner), perhaps with credit exceptions, is subject to the open account agreement, and the lien that it established.

The UCC1 can specifically state that the lien applies to future-acquired property of the same class, future credit extended under an open account agreement, or both. In this way, only one UCC1 statement needs to be filed to cover many different extensions of credit from the holding entity (or owner) to the operating entity.

Warning A lien on personal property can apply to future-acquired property of the same class, future credit extended under an open account agreement, or both. A lien on real property (i.e., a mortgage) also can apply to future extensions of credit. Here, the mortgage is termed an "open mortgage" agreement. However, a mortgage lien cannot apply to future-acquired property. The future-acquired real property would have to be transferred as security under a new mortgage after the property is acquired.

A UCC1 filing is effective for five years. It can be renewed through the filing of a Continuation Statement, provided this is done at least six months before the five-year period expires.

It is important that the owner have the filing officer record the file number, date and hour of filing on his copy of the document. Each state uses it own version of this form.

Although states usually accept a generic version, they will likely charge an additional processing fee if their form is not used.

Note that motor vehicles are treated differently than other types of personal property. A lien on a motor vehicle usually must be perfected by placing the lien on the actual motor vehicle title, and then submitting the title to the motor vehicle department.

Warning It is wise to have an attorney review any document before it is executed. Laws vary from state to state. For example, while states usually require certain exact language be used in an acknowledgement for a mortgage deed, this language differs by state. Moreover, documents should be adapted to the particular needs of the business and the owner.

The Business Tools section contains sample funding forms (including explanatory comments) that can be used in funding the operating entity with debt. Use these sample forms as guides, and have an attorney review and approve the documents before they are used.

In addition, the small business owner may want to consider what effect encumbering assets will have on the business entity's ability to borrow through "asset-backed" loans. These are loans secured by the business's equipment and inventory.

Here, a lender may require that the entity give the lender a priority position. This would enable the entity to secure funds through asset-backed loans and still protect the assets from other creditors.

It's important to understand that neither the recording of a mortgage nor the filing of a UCC1 statement actually creates the lien. The agreement between the holding entity (or owner) and the operating entity creates the lien.

A lien on real property must be created by a mortgage deed. The promissory note is a separate document detailing the nature of the loan, the repayment terms, etc. The mortgage is the lien, securing the promises made in the promissory note. The exact legal nature of the mortgage varies from state to state. In some states, the mortgage actually transfers legal title to the creditor, to secure the note. In most states, the mortgage simply creates a security interest in the property, without an actual transfer of title, similar to the way personal property is secured.

When a loan or other extension of credit is secured by personal property, the promissory note or agreement itself creates the lien. A separate agreement is unnecessary.

This underscores the importance of properly executing the underlying agreements. Of course, execution of all agreements must be formally authorized by the management of the entities.

Work Smart Business owners should remember that they also will be creditors with respect to their customers when selling them goods on credit provided by the business. A purchase-money security interest in consumer goods (goods purchased primarily for home or personal use) does not have to be recorded to be perfected. The UCC1 financing statement must be perfected by filing only if the goods involved are used in a business (this is why liens on the operating entity's business assets need to be recorded). However, sometimes an asset has a mixed use, part personal and part business. This is common today with many people starting small businesses and using home offices, and purchasing mixed-use equipment such as a home computer. The primary use (e.g., business versus personal miles driven for a vehicle, or business versus personal hours of computer usage) will determine whether the lien must be recorded to be perfected. In one case, a consumer purchased a $3,000 computer, telling the merchant that it would be used for personal use, as part of her teaching assignments, and in a variety store. The buyer financed the purchase in an agreement giving the merchant a lien on the computer. The merchant did not record the lien. In a Chapter 7 bankruptcy proceeding, the court held that the lien was not perfected, because the goods were purchased primarily for business use. Accordingly, the merchant lost the $3,000. Small business owners who provide credit for goods they sell should have the buyer specify, in the credit agreement, that the purchase is primarily for personal or household use, or file the lien in a UCC1 financing statement.

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