Does Revised Article 9 Increase the Risk of Fraud Through Unsigned Termination Statements?
by Rob Charles, Lewis and Roca LLP, Tucson, Ariz.
Under Revised Article 9 of the Uniform Commercial Code, a recorded financing statement must be “authorized” by the debtor, but is not required to be signed by the debtor. Similarly, a termination statement must be “authorized,” but is not required to be signed by the secured party. This lack of a signature requirement, in combination with the ease with which a financing statement or a termination statement may be filed (typically electronically), may lead to an increased risk of fraud or loss for parties relying on recorded UCC statements.
A financing statement provides record notice of a potential security interest. Revised Article 9 replaces the requirement that a financing statement be signed by the debtor with a requirement that the debtor authorize the financing statement in a written or electronic record that is “authenticated” (signed, executed or otherwise adopted) by the debtor. UCC §§9-102(a)(7) and 9-509(a)(1). By authenticating or becoming bound as a debtor by a security agreement, the debtor automatically authorizes the filing of an initial financing statement or an amendment covering the collateral provided for by the security agreement (and any identifiable proceeds of that collateral). UCC §9-509(b). Moreover, if collateral is transferred to a third-party transferee subject to an existing security interest, the transferee (also deemed a “debtor” under Revised Article 9) is deemed to have authorized the existing secured party to file an initial financing statement or amendment covering such collateral as property of the transferee. UCC §9-509(c).
Financing statements can also be amended (UCC §9-512) or terminated (UCC §9-513) without the debtor’s or the secured party’s signature. Unless an amendment adds collateral or a debtor, the secured party of record is generally the only entity that can authorize the filing of an amendment or termination statement. UCC §9-509(d). A debtor, however, may file a termination statement without the secured creditor’s authorization when the secured party fails to comply with its duties to terminate the financing statement under UCC §9-513, such as when the obligation secured by the collateral has been paid in full. UCC §9-509(d).
Whether or not a financing statement, amendment or termination has been authorized by the appropriate party is of utmost importance to those who are relying on the accuracy of UCC filings. If a financing statement, amendment or termination statement has not been authorized (or ratified) by the appropriate party, the filing is wholly ineffective. See UCC §9-510(a) (“A filed record is effective only to the extent that it was filed by a person that may file it under Section 9-509.”).
The foregoing rules under Revised Article 9 make for some interesting risks for lenders. Assume, for example, that a debtor asks a lender for a loan secured by a lien on collateral. The lender conducts an unofficial UCC search on the filing officer’s Web site, sees that the debtor had previously granted another lender a lien on the collateral, but that a termination statement was filed releasing the lien. Under UCC §9-513(d), the prior filed financing statement should no longer be effective as a result of the termination statement. However, is the new lender really free to lend without risk? Should the new lender’s counsel suggest any additional due diligence?
Recall that under UCC §9-509, if an apparent termination statement is filed by an unscrupulous debtor (or anyone else) without the secured creditor’s authorization, it is wholly ineffective and, unless ratified by the secured creditor, will not cut off the continuing effectiveness and priority of the secured creditor’s lien. Thus, while it may appear that a prior financing statement has been terminated and that a new lender is free to lend without risk, that is not necessarily the case.
If the borrower is dishonest and filed the unauthorized termination statement in order to persuade the new lender to advance funds to the borrower, the new lender will likely end up on the losing end of a priority dispute with the pre-existing secured creditor. Understanding that a termination statement is ineffective unless authorized by the existing secured party of record, a new lender may consider whether an inquiry of the prior lender is warranted. Such an inquiry can be difficult, time consuming and perhaps hard for the client to understand. Instead, the new lender may consider products that insure the priority of the new lender’s lien in order to shift the risk from the new lender (or its counsel) to an insurance company.
Consider a related situation with an entirely different outcome. If an apparent termination statement was a mistake, where the secured creditor did not intend the termination, but nonetheless authorized the filing, it would presumably be effective. Nothing in the UCC allows a creditor to avoid the effect of a mistake. Indeed, courts have repeatedly held the secured creditor bound by its mistake, particularly in the context of an effort by a trustee in bankruptcy to avoid the alleged secured lien.
What if the first secured party subsequently discovers that the apparent termination statement was incorrectly or inappropriately filed, either due to an unscrupulous debtor or a mistaken filing? Is there anything that the secured party can do? Can the secured party provide record notice that the termination filing was unauthorized and thereby “undo” the effect of the termination statement? A secured party may file an amendment to the “terminated” financing statement and put a note in item 13 (“additional information”) describing the circumstances. See UCC §9-512. Alternatively, the secured party may convince an honest/cooperative debtor to file a correction statement under UCC §9-518 indicating that the termination was “wrongfully filed.” However, the creditor may not itself file a correction statement because the only person authorized to file a correction statement is the person under whose name the record is indexed, i.e. the debtor. UCC §9-518(a).
In this situation, a power of attorney granted by the debtor to the secured party could be helpful. Through the security agreement or another document, the debtor could grant the secured party a durable power of attorney in sufficient scope to address this type of filing. The secured party could then file a correction statement under §9-518 to attempt to create a record that the purported termination statement was not effective.
Every human process, whether filing signed or authorized financing or termination statements, can be abused by the dishonest. Revised Article 9 changed the mechanism for potential fraud from a forged signature to an unauthorized signature. Counsel for a secured party needs to evaluate the risk potential as part of the representation.