USA: There could be trouble ahead...

Banks need to check whether companies borrowing money are located or do business with the US, says corporate lawyer Jeremy Glover. 

It is important for a financing bank (secured party) to enquire whether or not a party providing security (debtor) in the context of a financing transaction is located or has a “place of business” in the US.

If a debtor is located or has a “place of business” in the US and has granted personal property (tangible or intangible) in favour of a secured party as collateral to secure its underlying obligations, such secured party will need to make a filing under the Article 9 of the Uniform Commercial Code (UCC) in order to “perfect” its security interest and give legal notice to the world that such secured party has a legally protected interest in the personal property of the debtor.

Real estate is generally not within the scope of Article 9 of UCC. Each state in the US has enacted its own UCC. Although most states follow the standard UCC, there are some differences in the filing requirements of each state that should be considered on a case-by-case basis as the filing will need to be made in each state in which the debtor has a place of business.

A security interest is created and “attaches” in favour of the secured party once an agreement in respect of such security interest (e.g. in the form of a chattel mortgage, assignment, pledge, charge, etc.) is entered into by both parties (security agreement).

The Secured Party has contractual remedies under any such security agreement to protect itself in the event that the debtor breaches the security agreement. Accordingly, “perfection” does not provide a higher level of protection for the security party vis-à-vis the debtor; but rather, it protects the secured party’s interest and priority vis-à-vis third parties who may also have claims against the debtor (e.g. other creditors of the debtor, the bankruptcy trustee or purchasers of the collateral) or who may have claims against the same collateral, subject to certain specific exceptions which are not dealt with in this article.

The general rule of “perfection” is “first to file, first priority” although there are various exceptions (not addressed in this article). Accordingly, secured parties should keep in mind that their priority is not determined by the date of the security agreement; but rather, by the date of “perfection”. Perfection can be achieved by either (i) filing a financing statement, or (ii) taking possession of the collateral (which is often times not feasible or accepted by debtors).

In order for the secured party to protect its priority in respect of a security agreement, US correspondent lawyers should be instructed to conduct searches for financial statements that have been previously filed and which are still effective (keeping in mind that this search will not reveal the existence of any third party creditors who have achieved perfection by taking possession of the collateral).

In the event that other secured parties exist prior to the perfection of the relevant secured agreement (i.e. with a higher level of priority), the secured party will need to notify them.

Since it is an additional cost to conduct a search in respect of every debtor for each transaction, it is common for secured parties to require debtors to include a covenant or representation in the security agreement stating that it does not have a place of business in the US giving the secured parties recourse under the underlying loan documentation.

Corporate lawyer Jeremy Glover is a partner at Stephenson Harwood.