Loans and Liens and . . . What Can Go Wrong Here (Part 2)? The Devil is in the Details – Protecting a Lender’s Collateral Position Under the UCC

By: Jack Easterbrook

The lender gets loan documents signed by the borrower and takes collateral from the borrower to secure the debt. It sounds easy and familiar. So what could go wrong? The progression of cases interpreting the Uniform Commercial Code (UCC) provides insight into the mistakes, large and small, that can create unexpected exposure for lenders and surprise defenses for borrowers. Earlier this year two new cases shed additional light on this question. This article takes up the second of these two (and follows an earlier article by the author , which addressed the other new case).

Don’t Count on Equitable Arguments to Work in Protecting Lien Rights

DivLend (“Lender”) made a loan to Ajax (“Borrower”) secured by 30 vehicles. The agreement between Lender and Borrower granted the security interest in the vehicles. Although this agreement was titled a lease agreement, the court observed and the parties agreed that the transaction was really intended to be a secured loan. Title to the vehicles (the collateral) was evidenced by certificates, so the Lender was required to deliver the original certificates to the department of motor vehicles along with a notice of lien signed by the borrower (owner of the vehicles) and the requisite fee. The lender obtained the certificates, but the loan closed without the Borrower executing the notices of lien.

The loan agreement contained provisions, as well, that the Borrower must cooperate with the Lender. Relying on these, the Lender made multiple attempts to have the notices of lien signed but they never were executed. About seven months later an involuntary bankruptcy petition was filed against the Borrower.

The court disregarded the Borrower’s non-cooperation and held that the Lender was unsecured because it had not perfected its security interest (the case was decided under New York law). According to the court, the Lender could have protected itself by: (1) having the notices signed before advancing funds; or (2) exercising its rights to accelerate and reclaim the vehicles once it became apparent that the Borrower was not signing the notices. The Lender had not done either of these.

The bankruptcy court conceded that the Lender held an equitable lien based on the Borrower’s lack of cooperation. While this might have had value in some situations, in bankruptcy it did not trump the trustee’s strong arm powers to avoid an equitable lien.

The takeaway here is that the courts cannot be counted on to protect the lender, even when the borrower’s conduct is causing the problem. The courts, instead, expect the lender to take advantage of its legal rights if it is not obtaining the cooperation it needs. Fangio v. DivLend Equipment Leasing, LLC (In re Ajax Integrated, LLC), 2016 WL 1178350 (Bankr. N.D.N.Y. Apr. 4, 2016).

A related item: if a loan agreement has post-closing requirements, the lender must take action if the requirements are not met. The argument that the borrower would not cooperate is unlikely to prevail, at least in bankruptcy court.

The information appearing in this blog does not constitute legal advice or opinion. Such advice and opinions are provided by the firm only upon engagement with respect to specific factual situations. Specific questions relating to this article should be addressed directly to Strategy Law, LLP.