SBA Digest: Nuances of Perfecting a Purchase Money Security Interest

A Purchase Money Security Interest ("PMSI") gives a lender a priority security interest over other senior creditors in the collateral of a borrower. A PMSI can only be obtained if a Lender closely follows the rules governing security interests in personal property collateral under Article 9 of the Uniform Commercial Code, as adopted in each respective state. The availability of a PMSI allows borrowers who have previously pledged all of their personal property as collateral for commercial loans to acquire additional financing, often to obtain specific equipment or inventory to expand their business. SBA Lenders must be cognizant that the method for perfecting a PMSI varies depending on the type of collateral involved. Failure to strictly comply with the PMSI rules can result in a failure to properly secure collateral and lead to a violation of the SBA Authorization.

Basis for A PMSI

A PMSI requires: 1. The secured party gives new value; and 2. The new value enables the borrower to acquire an interest in certain goods. The loan must therefore allow the borrower to purchase or acquire rights in, all or part of the collateral. The new value is not necessarily limited to the purchase price for the collateral, but can also include taxes, freight, and other expenses incurred to acquire the collateral. Additionally, a refinance of a PMSI retains its priority under the Revised UCC. Note: It is important for lenders to provide loan proceeds directly to sellers/vendors, where possible, to best document that the loan allowed the borrower to acquire the collateral. If the borrower has placed a deposit for the purchase, it is also best for the lender to pay the purchase price in full and ensure the seller refunds the deposit to the borrower.

Types of PMSI

A PMSI may only be taken in goods and software. Article 9 defines "goods" include, but are not limited to, consumer goods, crops, fixtures, equipment, inventory, livestock, and manufactured homes. A PMSI therefore may not be taken in accounts, chattel paper, documents, general intangibles, and instruments.

Purchase Money Security Interest in Inventory

Acquiring a PMSI in inventory can be a tricky road for lenders because they are different than the "typical" process for perfecting a PMSI. To obtain a PMSI in inventory, a Lender must: 1. Have perfected its lien when the borrower receives possession of the inventory; 2. Send an authenticated notification to the holder of the conflicting security interest, i.e. the then senior secured lender; 3. Provide the holder of the conflicting security interest notification within five years before the borrower receives possession of the inventory; and 4. Ensure the notification states that the person sending the notification has or expects to acquire a PMSI in inventory of the borrower and the notification described the inventory. It is imperative that lenders understand there is no 20-day grace period.

The description in the notification should be specific and describe the collateral in more than just labeling it as "inventory". A description of the type of inventory financed and a reference to subsequent shipments is advisable. Note: A PMSI in inventory has limited follow through to proceeds. An inventory PMSI only has priority over chattel paper and instruments constituting proceeds, and in other identifiable "cash" proceeds received on or before delivery of the inventory to the buyer. Therefore, an inventory PMSI does not extend to accounts or cash payments received after delivery of the inventory to the buyer. This PMSI will not have priority over senior secured lender with a perfected security interest in accounts (i.e. accounts receivable). Therefore, the commingling of the cash proceeds of inventory in a general operating account may impede a PMSI creditor from enforcing its interest. Moreover, once the proceeds of the original collateral are deposited in a deposit account, the rules governing perfection of deposit accounts control, thus exposing the PMSI creditor to a losing claim versus a non-PMSI creditor with a perfected security interest in the same account.

Purchase Money Security Interest in Equipment

A PMSI in equipment must be perfected when the borrower receives the collateral or within twenty (20) days thereafter. A lender must therefore properly file its financing statement within twenty (20) days of when the borrower "receives possession of the collateral". If the lender files its financing statement within this period, it enjoys priority over other, senior blanket liens. Many disputes arise as to when the borrower receives possession of the collateral, especially when the collateral is delivered in installments or over time. Note: lenders should always pre-file their financing statement whenever possible. The UCC does not require the delivery of collateral prior to filing a financing statement, so the best practice is to file as soon as possible and remove potential confusion about the delivery date of goods. Additionally, lenders should always obtain copies of all delivery documents for its file, in the event a conflicting creditor challenges the PMSI status.

Conclusion

The PMSI rules are strictly enforced. Courts have frequently found PMSI creditors to lose priority based on failure to follow the PMSI rules. Particularly, courts have often looked to deficiencies in the notice to conflicting creditors as a basis to deny PMSI status in inventory. Further, the twenty (20) day deadline to file a financing statement is a hard and fast rule. If the lender does not file within the twenty (20) day deadline, its security interest will be perfected, but priority will default to the "first to file" rule.

Loan conditions that require a PMSI present special challenges. SBA Lenders must be diligent in following the rules to ensure proper PMSI lien perfection and compliance with the SBA Loan Authorization. For more information regarding ensuring enforceability of a PMSI, please contact the attorneys of Lewis Kappes, specializing in SBA guaranteed loan transactions:

Chris Poling: cpoling@lewis-kappes.com

Kevin Morrissey: kmorrissey@lewis-kappes.com

Scott Oliver: soliver@lewis-kappes.com