UCC Security Interests in Proceeds of Collateral ...media.straffordpub.com/products/ucc-security-interests-in-proceeds-… · 1-866-871-8924 and enter your PIN when prompted. Otherwise,

UCC Security Interests in Proceeds of

Collateral: Perfection, Priority and Impact of

Debtor's Bankruptcy

Today’s faculty features:

1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific

The audio portion of the conference may be accessed via the telephone or by using your computer's

speakers. Please refer to the instructions emailed to registrants for additional information. If you

have any questions, please contact Customer Service at 1-800-926-7926 ext. 1.

TUESDAY, MARCH 20, 2018

Presenting a live 90-minute webinar with interactive Q&A

James T. Bentley, Special Counsel, Schulte Roth & Zabel, New York

Tips for Optimal Quality

Sound Quality

If you are listening via your computer speakers, please note that the quality

of your sound will vary depending on the speed and quality of your internet

connection.

If the sound quality is not satisfactory, you may listen via the phone: dial

1-866-871-8924 and enter your PIN when prompted. Otherwise, please

send us a chat or e-mail [email protected] immediately so we can address

the problem.

If you dialed in and have any difficulties during the call, press *0 for assistance.

Viewing Quality

To maximize your screen, press the F11 key on your keyboard. To exit full screen,

press the F11 key again.

FOR LIVE EVENT ONLY

Continuing Education Credits

In order for us to process your continuing education credit, you must confirm your

participation in this webinar by completing and submitting the Attendance

Affirmation/Evaluation after the webinar.

A link to the Attendance Affirmation/Evaluation will be in the thank you email

that you will receive immediately following the program.

For additional information about continuing education, call us at 1-800-926-7926

ext. 2.

FOR LIVE EVENT ONLY

Program Materials

If you have not printed the conference materials for this program, please

complete the following steps:

• Click on the ^ symbol next to “Conference Materials” in the middle of the left-

hand column on your screen.

• Click on the tab labeled “Handouts” that appears, and there you will see a

PDF of the slides for today's program.

• Double click on the PDF and a separate page will open.

• Print the slides by clicking on the printer icon.

FOR LIVE EVENT ONLY

Strafford UCC Security Interests in Proceeds of Collateral: Perfection, Priority and Impact of Debtor’s Bankruptcy

March 20, 2018

James T. Bentley Special Counsel Schulte Roth & Zabel

Strafford UCC Security Interests in Proceeds of Collateral: Perfection, Priority and Impact of Debtor’s Bankruptcy | 6

What We Will Cover

• Significance of After-Acquired Property and Proceeds

• How to “Identify” Proceeds – Goods vs. Non-Goods

• Commingled Collateral and Accessions

• Post-Bankruptcy Liens on After-Acquired Property and Proceeds

• Equities of the Case

• Cash Collateral

• Perfecting Liens in Unique Collateral

• Use of DIP Lien/Adequate Protection Lien to Address Collateral Gaps


Liens on After-Acquired Property and Proceeds

• In the commercial lending context, Borrowers often agree to an “after-acquired property clause,” and grant security interests in substantially all of their personal property, including their equipment, inventory and accounts, now existing or acquired after the loan is made. UCC § 9-204.

• A lender also typically has a lien on the proceeds of both its original collateral (i.e., collateral existing at the loan closing) and on the debtor’s after-acquired property. UCC §§ 9-203(f); 9-315.


Definition of After-Acquired Property

• Section 9-204 of the UCC addresses what constitutes “After-Acquired Property”

– After-Acquired collateral. Except as otherwise provided in subsection (b), a security agreement may create or provide for a security interest in after-acquired collateral.

– When after-acquired property clause not effective. Under a term constituting an after-acquired property clause, a security interest does not attach to:

• Consumer goods, other than an accession,* when given as additional security, unless the debtor acquires rights to them within ten days after the secured party gives value; or

• A commercial tort claim.

– Future advances and other value. A security agreement may provide that collateral secures, or that accounts, chattel paper, payment intangibles, or promissory notes are sold in connection with future advances or other value, whether or not the advances or value are given pursuant to commitment.

* “Accession” means goods that are physically united with other goods in such a manner that the identity of the original goods is not lost. § 9-102(1).


Definition of Proceeds

• Under the UCC, “proceeds” are defined as:

– “Proceeds,” except as used in Section 9-609(b), means the following property:

• Whatever is acquired upon the sale, lease, license, exchange or other disposition of collateral;

• Whatever is collected on, or distributed on account of, collateral;

• Rights arising out of collateral;

• To the extent of the value of collateral, claims arising out of the loss, nonconformity or interference with the use of, defects or infringement of rights in, or damage to, the collateral or

• To the extent of the value of collateral and to the extent payable to the debtor or the secured party, insurance payable by reason of the loss or nonconformity of, defects or infringement of rights in, or damage to, the collateral.


Liens on Proceeds

• Typically, to perfect a security interest in goods, you need to file a financing statement or obtain possession.

• Significance of § 9-315. With proceeds, however, UCC Section 9-315 provides for the automatic perfection in identifiable proceeds of original collateral.

• § 9-315. Secured Party’s Rights on Disposition of Collateral and in Proceeds

– Disposition of Collateral: Continuation of security interest or agricultural lien; proceeds

• Except as otherwise provided in this article and in Section 2-403(2):

– A security interest or agricultural lien continues in collateral notwithstanding sale, lease, license, exchange or other disposition thereof unless the secured party authorized the disposition free of the security interest or agricultural lien; and

– A security interest attaches to any identifiable proceeds of collateral.

– When commingled proceeds are identifiable

• Proceeds that are commingled with other property are identifiable proceeds if:

– The proceeds are goods, to the extent provided by Section 9-336; and

– The proceeds are not goods, to the extent that the secured party identifies the proceeds by a method of tracing, including application of equitable principles, that is permitted under law other than this article with respect to commingled property of the type involved.


Liens on Proceeds – Perfection of Security Interest in Proceeds

• A security interest in proceeds is a perfected security interest if the security interest in the original collateral was perfected.

– Continuation of perfection • A perfected security interest in proceeds becomes unperfected on the 21st day after the

security interest attaches to the proceeds unless the following conditions are satisfied: – A filed financing statement covers the original collateral;

– The proceeds are collateral in which a security interest may be perfected by filing in the office in which the financing statement has been filed; and

• The proceeds are not acquired with cash proceeds;

• The proceeds are identifiable cash proceeds; or

• The security interest in the proceeds is perfected, other than under subsection (c), when the security interest attaches to the proceeds or within 20 days thereafter.

– When perfected security interest in proceeds becomes unperfected • If a filed financing statement covers the original collateral, a security interest in proceeds

which remains perfected under subsection (d)(1) becomes unperfected at the later of:

– When the effectiveness of the filed financing statement lapses under Section 9-515 or is terminated under Section 9-513; or

– The 21st day after the security interest attaches to the proceeds.


Identifying Proceeds

• Significantly, the UCC’s automatic lien in proceeds only extends to identifiable proceeds.

• Determining whether proceeds are “identifiable” can be tricky. An easy example of proceeds is cash from the sale of a car.

• The reassuring point here is that the interest in the proceeds is automatically perfected if the security interest “in the original collateral was perfected.” Under subsection (d), that perfection continues for 20 days; if the creditor wishes to continue its perfection beyond 20 days, it must either fit within one of the other subsections or take whatever action would be necessary to perfect a security interest in the particular assets involved.


Identifying Proceeds When the Proceeds Are Goods

• Commingled Goods, § 9-336

– “Commingled goods”

• In this section, “commingled goods” means goods that are physically united with other goods in such a manner that their identity is lost in a product or mass.

– No security interest in commingled goods as such

• A security interest does not exist in commingled goods as such. However, a security interest may attach to a product or mass that results when goods become commingled goods.

– Attachment of security interest to product or mass

• If collateral becomes commingled goods, a security interest attaches to the product or mass.


Identifying Proceeds When the Proceeds Are Goods

• Perfection of security interest

– If a security interest in collateral is perfected before the collateral becomes commingled goods, the security interest that attaches to the product or mass under subsection (c) is perfected.

• Priority of security interest

– Except as otherwise provided in subsection (f), the other provisions of this part determine the priority of a security interest that attaches to the product or mass under subsection (c).

• Conflicting security interests in product or mass

– If more than one security interest attaches to the product or mass under subsection (c), the following rules determine priority:

• A security interest that is perfected under subsection (d) has priority over a security interest that is unperfected at the time the collateral becomes commingled goods.

• If more than one security interest is perfected under subsection (d), the security interests rank equally in proportion to the value of the collateral at the time it became commingled goods.


Example of Commingled Goods (Provided by the Official Comments to Section 9-336)

• Cake — One vendor supplies eggs; another, flour. Once the eggs are mixed with the flour to make the cake, both the eggs and flour lose their separate identities and become “commingled goods.”

• Off-Site processing is a pitfall of commingled goods. A company sends goods to a processor who commingles the goods into a new product. The company’s security interest will be subordinate to the pre-existing blanket lien of the processor’s bank lender, even though the goods were sent to the processor on a tolling basis only.

• A company that ships goods to another company — for processing or to be joined with other goods — cannot rely upon just a security agreement and UCC filing to protect itself against loss of the value of those goods in the event of a default by the processor or customer.

• Consider subordination agreement, just-in-time delivery and credit default insurance.


§ 9-335 Accessions • Creation of security interest in accession

– A security interest may be created in an accession and continues in collateral that becomes an accession.

• Perfection of security interest

– If a security interest is perfected when the collateral becomes an accession, the security interest remains perfected in the collateral.

• Priority of security interest

– Except as otherwise provided in subsection (d), the other provisions of this part determine the priority of a security interest in an accession.

• Compliance with certificate-of-title statute – A security interest in an accession is subordinate to a security interest in the whole which is perfected by compliance with the

requirements of a certificate-of-title statute under Section 9-311(b).

• Removal of accession after default

– After default, subject to Part 6, a secured party may remove an accession from other goods if the security interest in the accession has priority over the claims of every person having an interest in the whole.

• Reimbursement following removal

– A secured party that removes an accession from other goods under subsection (e) shall promptly reimburse any holder of a security interest or other lien on, or owner of, the whole or of the other goods, other than the debtor, for the cost of repair of any physical injury to the whole or the other goods. The secured party need not reimburse the holder or owner for any diminution in value of the whole or the other goods caused by the absence of the accession removed or by any necessity for replacing it. A person entitled to reimbursement may refuse permission to remove until the secured party gives adequate assurance for the performance of the obligation to reimburse.


Accessions vs. Commingled Goods

• An example of an accession is a car radio. An accession is effectively the opposite of “commingled goods”. § 9-336. (“Commingled goods” means goods that are physically united with other goods in such a manner that their identity is lost in a product or mass.)


Identifying Proceeds When the Proceeds Are Not Goods

• UCC § 9-315(b)(2) deals with commingled things that are not goods. The hardest collateral to trace is cash. To identify proceeds of cash, we use tracing rules.

• The Lowest Intermediate Balance Test

– Assume a secured creditor could prove the debtor had deposited $100,000 of proceeds into its bank account. Assume thereafter the lowest balance in the account is $90,000. In that case, the lowest intermediate balance fiction would treat the remaining $90,000 as identifiable cash proceeds of the secured creditor.

• Under the Lowest Intermediate Balance Test, if there are multiple deposits and withdrawals, we still look to the lowest balance


Bankruptcy Post-Bankruptcy Liens on After-Acquired Property and Proceeds

• Section 552(a) of the Bankruptcy Code provides the general rule that after-acquired property of the Debtor’s estate “is not subject to any lien resulting from any security agreement entered into by the debtor before the commencement of the case.”

• Section 552(b) provides an exception that permits the prepetition security interest to extent to proceeds, products, offspring or products acquired after commencement of the case, subject to certain exceptions.

• A prepetition security agreement may extend to rents generated by the collateral and to payments for the use and occupancy of rooms in lodging properties.


Section 552(a) Applies to All Consensual Liens

• Section 552(a) applies to all security interests, not just security interests governed by the UCC

• Section 552(a) only applies to consensual liens


Proceeds vs. After-Acquired Property

• The distinction between “after-acquired property,” in which a lender’s lien is cut off under § 552(a), and “proceeds” of a lender’s prepetition collateral, which is preserved under § 552(b), is not always clear

• Significance: Broad definition of proceeds (i) allows attachment of a security interest to a wider variety of property that is spun out of the original collateral and (ii) makes it easier for secured creditors to reach postpetition assets using § 552(b).


What Are Equities of the Case?

• Section 552(b) provides that a secured creditor’s lien on proceeds of its prepetition collateral extends to such proceeds acquired by the estate after the commencement of the case to the extent provided by such security agreement and by applicable nonbankruptcy law, except to any extent that the court, after notice and a hearing and based on the equities of the case, orders otherwise.

• “Equities of the case” is not defined. This is a rare and extraordinary remedy. Effectively, it is a weapon for general unsecured creditors to eliminate a secured creditor’s lien on proceeds. Courts seldom disregard a postpetition lien on proceeds based on the equities of the case.

• Consequence: When invoked, it can deprive a lender of its lien on some or all of the proceeds of its prepetition collateral. Thus, secured lenders typically will seek an “equities of the case” waiver in cash collateral and DIP orders.


Burden Rests With Secured Creditor

• The burden of proving that a pre-petition lien survives post-petition rests with the secured party. 11 USC §362(p)(2).


Cash Collateral

• The Bankruptcy Code provides that a debtor cannot use a secured lender’s cash collateral without the lender’s consent or court approval.

• The Bankruptcy Code defines cash collateral as:

– “Cash collateral” means cash, negotiable instruments, documents of title, securities, deposit accounts, or other cash equivalents whenever acquired in which the estate and an entity other than the estate have an interest and includes the proceeds, products, offspring, rents, or profits of property and the fees, charges, accounts or other payments for the use or occupancy of rooms and other public facilities in hotels, motels, or other lodging properties subject to a security interest as provided in section 552 (b) of this title, whether existing before or after the commencement of a case under this title.

• 11 U.S.C. § 363(a)


Cash Collateral

• Limits on Debtor’s use

• Adequate protection and replacement liens


Unique Collateral & Practical Tips

• Commercial Tort Claims

• Rolling Stock (e.g., vehicle fleet)

• Leasehold Mortgages (e.g., restaurant chain/fixtures)



• Government licenses (e.g., FCC, gaming and liquor)

– Use of special purpose entity

• Government receivables (e.g., Medicare and Medicaid)

– Anti-Assignment Rules

• Use of double-lock box



• Avoidance actions

• Revenue attributable to post-petition labor

– In re Cafeteria Operators, 299 B.R. 400 (Bankr. N.D. Texas 2003)



• Why does it matter?

• Extent of credit bid rights

– A “credit bid” allows a secured creditor to offset the purchase price by the amount of its secured claim, a right expressly provided for in section 363(k) of the Bankruptcy Code

– Implication of lien on proceeds in credit bid scenarios

• Entitlement to adequate protection

• Entitlement to post-petition interest and legal fees

– A secured creditor is entitled to post-petition interest up to the value of the collateral securing its lien. 11 U.S.C. § 506(b)


Use of DIP Lien/Adequate Protection Lien to Address Collateral Gaps

• Secured creditor’s objective

• Creditors’ committee concern

• Proceeds of collateral later determined to be unencumbered


About the Speaker

James T. Bentley counsels and represents ad hoc committees, private equity funds, financial institutions, bondholders, multiemployer pension funds, unsecured creditors, equity holders and others. James represents clients in complex transactions, litigation financing, advisory matters relating to restructuring, litigation, reorganizations and out-of-court workouts across a broad range of industries, including automotive, gaming, restaurants, retail and manufacturing. He regularly collaborates with clients on investments in distressed and bankrupt companies with complex corporate and capital structures, including credit and indenture analysis, exit strategies, including negotiation of plans of reorganization, financings and acquisitions. James frequently litigates creditors’ rights issues, including claim challenges, cash collateral, withdrawal liability claims, stay relief and director and officer liability claims. He regularly negotiates loan modifications, forbearance agreements and other workout solutions.

James T. Bentley Special Counsel Schulte Roth & Zabel [email protected]


Disclaimer

This communication is issued by Schulte Roth & Zabel LLP for informational purposes only and does not constitute legal advice or establish an attorney-client relationship. In some jurisdictions, this publication may be considered attorney advertising. ©2018 Schulte Roth & Zabel LLP. All rights reserved. SCHULTE ROTH & ZABEL is the registered trademark of Schulte Roth & Zabel LLP. This communication displays certain trademarks and logos owned by the companies discussed herein. All such trademarks remain property of their respective owners, and are used only directly to identify or describe the companies being discussed herein. Their use is not intended to indicate and in no way indicates any sponsorship, endorsement or affiliation of Schulte Roth & Zabel LLP, on the one hand, and the owners of such trademarks and logos, on the other hand.

Documents

UCC Security Interests in Proceeds of Collateral ...media.straffordpub.com/products/ucc-security-interests-in-proceeds-… · 1-866-871-8924 and enter your PIN when prompted. Otherwise,