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Small Errors Can Cause Catastrophic Outcomes

October 15, 2014, 07:00 AM
Related: Documentation

In the fast-paced, highly competitive industry of equipment leasing and finance, identifying potential clients and closing transactions can be challenging. Knowing that, once a lessor/lender secures the deal, the small and seemingly insignificant details may be overlooked. However, appropriately documenting and maintaining the transaction is important as overlooking small details sometimes leads to large problems, particularly in perfecting, renewing and terminating security interests granted to the lessor/lender in connection with the lease or equipment finance transaction. (1.) Here are some simple tips to avoid the common errors.

Documenting the Transaction

To properly perfect a lessor/lender’s security interest in the leased/financed equipment and therefore preserve its interest, it is critically important to correctly identify the actual legal name of the lessee/borrower on the UCC Financing Statement. If the lessee/borrower is an individual, identify the individual’s legal name as indicated on a driver’s license or other governmental-issued identification. Avoid nicknames, partial names or initials. If the lessee/borrower is a corporation, LLC or partnership, use the exact legal name as it appears in the organic public records filed with the secretary of state. Do not rely on certificates of good standing. Avoid d/b/a’s, abbreviations or shortened versions of the full legal name.

The effect of an error or omission in correctly identifying the lessee/borrower’s actual legal name can be catastrophic: if a third party searching the lessee/borrower’s correct legal name using the filing office’s standard search logic would not find the filing, it is considered seriously misleading under the law and the lessor/lender’s secured interest may be unperfected. 
In addition to identifying the legal name of the lessee/borrower, the equipment being financed must be adequately described so as to give reasonable notice to third parties. The law provides that a description of the equipment in which the lessor/lender maintains a security interest is sufficiently described in the underlying lease/finance agreement if it reasonably identifies the collateral. Examples include identification by specific listing, category, quantity, formula or procedure, or any other objectively determinable method of identification.  Note that description of collateral by type is not sufficient for commercial tort claims, consumer transactions for goods, securities accounts, and commodities accounts. 
The standard for adequately describing collateral in a UCC Financing Statement, however, is different. While describing collateral similar to that as stated in your lease/finance agreement is generally sufficient, a description in the UCC Financing Statement is sufficient if it reasonably puts other creditors on notice that the filing creditor claims a security interest. Stated differently, a collateral description is sufficient if it reasonably describes what is covered whether or not it is specific. If unsure of the collateral type or category, use a broad description. If a UCC Financing Statement puts a third party on notice that a creditor claims an interest in a type of equipment, this should be sufficient. However, be aware that the description of collateral in the UCC Financing Statement should not be broader than the grant of security identified in the lease/finance agreement.
Common errors with inaccurate descriptions include the failure to identify equipment make, model or number of items being covered. Errors in transcribing serial numbers are also common. Although some courts have taken a hard-line approach and found filings ineffective even though only one digit of a serial number was incorrect, most courts will take a more reasonable approach.  If serial numbers are used to describe collateral, also describe the item by make, model or type of equipment.  If describing collateral by type or category, be aware that identifying the wrong category – equipment rather than inventory – could be fatal.

Maintaining Perfection

Assuming the transaction is correctly documented, problems may still arise if a lessor/lender fails to preserve its perfected status. Typically, the perfection afforded by filing a UCC Financing Statement lasts five (5) years from the date of filing. A continuation statement can extend perfection another five years if filed within six (6) months before the date of lapse. The failure to file a continuation statement results in a lapse in perfected status and can result in a loss or subordination of the security interest in the equipment. An untimely filed continuation statement is ineffective. If a lapse occurs, a new UCC Financing Statement must be filed.

Additionally, a change in the lessee/borrower’s legal name requires the lessee/lender to file an amendment to the UCC Financing Statement identifying the same within four (4) months of the change or the lessor/lender will not be perfected in any changes to the equipment or to equipment acquired thereafter.  However, the UCC Financing Statement continues to be effective for equipment acquired before the change. If the lessee/borrower changes its state of residence/incorporation/organization, the same four (4) month amendment rules apply.
Special note for equipment constituting inventory: if financed equipment constitutes inventory (generally meaning it will be held for lease or sale by the lessee/borrower) and another lender has an existing properly perfected blanket security interest in the lessee/borrower’s assets, to obtain a purchase money security interest in your equipment you must file a UCC Financing Statement before it is delivered and provide notice to all blanket lenders.  Doing so carves out the equipment you financed from being construed as general inventory of the lessee/borrower and prevents your security interest from being considered subordinate to the blanket lender. Additional notice must be provided to all blanket lenders if the UCC Financing Statement is continued. The crucial point is the creditor needs to be aware of the lessee/borrower’s intended use of the equipment. If a lessee/borrower intends to sublease the equipment, it may become inventory and subject to a prior creditor’s security interest.

Termination of Security Interests

Once the lessee/borrower completes all obligations in connection with the transaction, the lessor/lender must terminate its interest in the equipment. For consumer goods, the lessor/lender must file a UCC termination statement within twenty (20) days. If commercial equipment, the lessor/lender must either file a UCC termination statement or deliver a copy of the same to the lessee/borrower within twenty (20) days of the lessee/borrower’s request.

What happens if a termination is filed by mistake? In general, anyone may file a termination statement who is an authorized party of record. Generally, if filed by an authorized party of record, the termination is effective regardless of the filing party’s intent. If a termination is filed by mistake without authorization, a correction statement may be filed. Legally, this does not reverse the unauthorized termination, but it provides inquiry notice that the termination should be reviewed.

Unauthorized filings are ineffective. Although ineffective, an unauthorized termination may result in damages. Mistaken unauthorized terminations may lead to a subsequent creditor lending money to the lessee/borrower only to later learn that the termination was unauthorized and that a lessor/lender’s prior filing had priority over the lender’s filing. This may lead to litigation over a priority dispute.  
The point to remember is that terminations should be reviewed before filing and not merely filed as a matter of course. Often, UCC Financing Statements cover multiple lease/finance transactions. A mistakenly filed amendment terminating an entire financing statement could terminate the lessor/lender’s perfection on collateral securing other transactions.


(1.) Even though lease transactions may be governed by Article 2A, we recommend filing UCC Financing Statements as though Article 9 governs the transaction. This does not change the character of the transaction; however, it provides comfort should a court later determine the transaction is not a true lease, but rather a disguised security agreement.

Photo of Attorneys Benjamin J. Court, Joseph W. Lawver and Joshua A. Hasko of Law Firm Messerli & Kramer PA

Messerli & Kramer Attorneys
Messerli & Kramer PA
Ben Court, Joe Lawver, and Josh Hasko are attorneys at Messerli & Kramer PA, a highly regarded full-service law firm based in Minneapolis. They are part of the equipment leasing and creditors’ right team and have extensive experience in all aspects of equipment leasing and finance transactions and litigation, asset-based lending, and banking and finance. They routinely handle lease and loan documentation and enforcement matters, floor plan financing, replevins, collects and judgment enforcement, business and fraud litigation, portfolio acquisitions, bankruptcies and workouts, receiverships, and appeals throughout the upper Midwest and across the country.
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