Purchase Money Security Interests
June 10, 2020
Increase Your Chance to Collect When You Sell on Credit
If you sell goods to customers on credit, then you have to worry about the credit risk posed by your customer. Sometimes that risk is the result of general problems in the economy and other times it’s something specific to a particular customer. For example, a new customer’s business may not yet be fully up to speed or a long-standing customer might be going through a difficult period that may or may not end quickly. If you refuse to sell to these customers, that not only could affect your immediate top-line revenue, but it also could cause you to lose future sales as the customer’s business improves. Similarly, refusing to continue selling to a customer who is carrying an unpaid balance or paying a little slow may decrease the likelihood of that customer working their way out of trouble, paying your unpaid balance, or buying goods from you in the future.
One way to enhance a customer’s credit and decrease your risk in these situations is to take a security interest in the goods you sell or a customer’s other assets as collateral for repayment of the purchase price. Article 9 of the Uniform Commercial Code (UCC) provides a mechanism for obtaining and perfecting a lien on a business' assets to secure repayment and, although local modifications to this “uniform” law are adopted from time to time (so it is important to check the law governing a particular transaction), the UCC has been adopted in every State. If the customer’s assets are not already encumbered, then it might be possible to perfect a first-priority security interest in some or all of those assets. However, businesses often finance their accounts receivable or have working capital or other revolving lines of credit. In those situations, a bank or other lender already might have a “blanket” security interest in all the customer’s assets, including assets acquired in the future, as collateral for their loan. Although the UCC generally applies the maxim “first-in-time, first-in-right” to give the security interest first “perfected” priority over other security interests, Article 9 also gives manufacturers and sellers of goods the ability to step in front of or “prime” the bank’s blanket security interest.
Even if another lender has a pre-existing, perfected security interest in specific collateral, manufacturers and other sellers of goods can mitigate credit risks of new or struggling customers and step in front of the bank’s pre-existing security interest by taking and perfecting what is known as a “purchase money security interest” (PMSI) in the specific goods (whether equipment or inventory) that they sell to the non-consumer customer on credit and, in some cases, in identifiable cash proceeds upon the customer’s sale of those goods. A PMSI is a relatively simple and inexpensive security device. In order to use it successfully, however, the manufacture or seller must strictly follow some very specific rules before shipping goods to their customer and it is wise to obtain the advice of an attorney having extensive experience with the UCC and commercial law to assist in navigating those rules.
In order to insert their PMSI lien ahead of an earlier perfected blanket lien of a bank or other lender, among other things, (i) the manufacturer or seller of goods must obtain from the customer a written security agreement that complies with applicable provisions of the UCC and secures an obligation incurred and used for acquisition of the goods, (ii) the goods purchased must qualify as inventory or equipment of the customer, (iii) the manufacturer or seller must timely and properly perfect their own security interest, and (iv) the manufacturer or seller must satisfy the requirements to obtain priority and jump ahead of (or prime) prior interests. The requirements to prime the interests of previously perfected creditors are different for inventory than for equipment and certain other types of goods. Since one of the requirements to prime the interests of previously perfected creditors in collateral that will be inventory to your customer is to give required notice to other creditors, it is necessary to determine which jurisdictions to search and to review the public records of all appropriate jurisdictions. It also might be wise in some situations to restructure any debt that existed before the PMSI to avoid jeopardizing PMSI status for future credit extended to the customer. Finally, it is imperative that the manufacturer or seller mark their calendar to renew their notice within the time required by the UCC or their PMSI will no longer have priority.
If you sell goods to business customers on credit and either want to enhance a customer’s credit, structure a workout of existing debt, or ensure that your right to payment is secured, call the attorneys at Levy & Zeewy, LLC for assistance by one of our commercial law attorneys. Among other things, we have extensive experience in commercial law, the UCC and debtor-creditor relations, including UCC Article 2 (Sales of Goods), Article 2A (Leases), Article 3 (Negotiable Instruments), Article 4 (Bank Deposits and Collections), Article 4A (Funds Transfers), Article 5 (Letters of Credit), Article 6 (Bulk Transfers/Bulk Sales), Article 7 (Documents of Title), Article 8 (Investment Securities) and Article 9 (Secured Transactions).
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