When farmers file for bankruptcy protection and seek to reorganize or liquidate their farms, their lenders start looking for other sources to obtain payments for loans. There are a couple of scenarios that we have seen play out multiple times that have put dealers in the crosshairs of secured lenders looking to get paid. Both situations involve seemingly minor issues with the Uniform Commercial Code (UCC), but they can easily cost dealers tens of thousands of dollars or more.
Almost every lender that provides financing for equipment purchases requires the dealer to provide contracts that give the lender a first priority security interest on the equipment they finance for the customer. Usually the lender can obtain a purchase money security interest to obtain the priority desired. The UCC, however, contains technical requirements that can screw up the priority of the security interest, including issues relating to the customer’s name.
Different states have enacted differing versions of the UCC, but the best practice is to use the customer’s name directly from his or her driver’s license. Some states specifically require the use of the driver’s license name while others include it as an option. Failure to use the name from a government issued identification puts dealers at risk for having a UCC financing statement deemed “seriously misleading” and therefore unenforceable.
For instance, the use of a common nickname, like Jim, in place of a formal name on a driver’s license, like James, can be enough to allow a bankruptcy trustee or another secured creditor to claim the financed equipment ahead of the lender that financed the equipment.
We have also seen an issue with the failure to use the correct version of first names that have multiple spellings. For instance, a person may be named Jackson, Jaxson or Jaxon and the only way to be certain which is correct is to actually see the driver’s license. Particular care should be exercised when completing online forms that have auto-fill features. Once an incorrect spelling is used, it can be repeated over and over, creating issues with liens on multiple pieces of equipment. Checking the driver’s license every time and using that name avoids these issues.
Eliminating these issues is critical because if the UCC filing doesn’t deliver the required priority to the finance company, the finance company will usually be able to charge-back the loan to you, even if the loan is otherwise non-recourse. This leaves you in the position of being out of pocket with respect to the loan balance and facing the prospect of spending time and attorney’s fees to try to recover some of the balance back through the bankruptcy process.
The other scenario we have seen that causes dealers significant problems is the failure to identify all possible liens that may attach to trade-in equipment. It is not uncommon for a customer to purchase equipment, obtain financing, pay off the equipment and then seek to trade it in when the customer decides to upgrade. This seems easy – no need to worry about a payoff balance because the dealer already knows the equipment has been paid off. Unfortunately, that is not the end of the story.
Customers frequently have operating loans with banks or other lenders that include a lien on all of the farmer’s assets or, at least, all of a certain category of assets such as equipment. The bank’s lien extends to the entire category, including the piece of equipment that serves as the trade-in. Normally, this is not an issue because the customer makes payments on the loan from the bank as well as the loans for equipment purchases.
When bankruptcy is filed, a bank is going to look through the bankruptcy schedules and compare it with its prior list of equipment to determine whether the now-bankrupt farmer still has the bank’s collateral. If the equipment list has changed, the bank will start looking to determine what happened to the collateral and if a trade-in occurred without a release of the bank’s lien, the dealer is going to get a demand letter for return of the trade-in or payment for the value of the collateral.
This problem can be avoided completely by doing a UCC lien search prior to accepting any trade-in. Collateral descriptions need to be read to determine whether there is any conceivable language that provides notice that another lender claims an interest in the equipment. Blanket liens are the most common source for problems, but the equipment may also be specifically identified. If you ask, most lenders are willing to release their liens because they normally receive replacement collateral in the form of any equity in new equipment. If there is no release, you should reject the trade-in.
Attention to detail at the time of a transaction can prevent these common occurrences from costing your dealership. Take the time to obtain the driver’s license and use extra care to make sure the name on all contracts matches exactly. When taking a trade-in, do a lien search for all possible lenders that may claim an interest in your customer’s assets to make sure that any necessary releases are obtained. This will avoid taking on a risk that you never intended to take.
This article is intended to provide general recommendations and is not intended to be legal advice. You should always consult your attorney for advice unique to you and your business. Please note that any estimates of tax consequences are based on the current tax code and could change based on future changes in the law or regulations.
Article Written By Dave Shay
DAVID E. SHAY (1962-2020) was a member of the Equipment Dealer Group at Seigfreid Bingham, P.C. The firm serves as legal counsel to the Western Equipment Dealers Association (WEDA). This article is intended to provide general recommendations and is not intended to be legal advice. You should always consult your attorney for advice unique to you and your business.