Know Your Collateral When Perfecting Security Interests 

Creditors routinely take security interests in collateral as a hedge against a borrower’s failure to satisfy outstanding debt obligations. For creditors, the importance of perfecting these security interests cannot be understated. The reason: perfecting a security interest (essentially, putting the world on notice of a creditor’s superior rights in identified property) gives the secured creditor a priority claim on specified collateral as compared to another party’s unsecured claims on a debtor’s assets.  

This begs the question: how does a creditor go about perfecting its security interest in personal property? The answer: it depends upon the collateral at issue, but in all cases, the Uniform Commercial Code (UCC) governs the method of perfection. 

Certificated and Uncertificated Securities 

Shares (or comparable equity interests) in a corporation, business trust, or similar entity are defined as a “security” for purposes of Article 8 of the UCC and “investment property” under Article 9. Where a share is represented by a physical certificate, it is characterized as a certificated security. 

A security interest in a certificated security—or any uncertificated security, for that matter—can be perfected by the proper filing of a UCC-1 financing statement. Alternatively, a secured party can perfect an interest in a certificated security by control of the certificate. To do so in the case of a stock certificate, for example, the secured party (or the secured party’s intermediary) must obtain actual possession —or take delivery—of it, along with an executed stock power indorsed to the secured party (or in blank), which allows the secured party to transfer the certificate in the event the collateral is foreclosed upon.  

Of course, in our digital age, ownership in an equity interest is not always evidenced by a physical certificate. Rather, electronic certificates may be entered in a company ledger. This is an example of an uncertificated security, in which ownership is evidenced by account statements issued by the company, the company’s transfer agent, or a broker-dealer. 

Not unlike a certificated security, a security interest in uncertificated securities can be perfected two ways: (1) by properly filing a UCC-1 financing statement or (2) by control. As for control of an uncertificated security, it is obtained by either re-registering the investment property in the name of the secured party or by the execution of a control agreement with the issuer of the uncertificated security.  

Limited Liability Companies and Limited Partnerships  

Equity interests in limited liability companies and limited partnerships are treated as either “general intangibles” or “investment property” under Article 9 of the UCC.  

In order for a secured party to treat an interest in an LLC or LP as a “security” and “investment property” under the UCC and be able to perfect its security interests accordingly, the issuer must take additional steps to effectively opt-in to Article 8. Of note, an Article 8 opt-in provision can generally be found in the issuer’s governing document (generally, the operating, LLC or LP agreement) or on the face of the certificate of a certificated LLC or LP interest, and to be effective, the opt-in provision must expressly provide that the LLC or LP interest at issue is being treated as a “security” pursuant to the UCC.  

In the absence of an effective Article 8 opt-in provision, an LLC or LP interest will be characterized as a “general intangible” (whether or not the equity interest is certificated), and the only method of perfecting a security interest in a “general intangible” is to properly file a UCC-1 financing statement. Parenthetically, the priority rule of first to file a UCC-1 financing statement will apply in the event of multiple security interests in the LLC or LP interest in question. 

So that an LLC or LP interest is treated as a “security” and not a “general intangible” for purposes of perfecting the interest, a secured party may want to request the issuer to opt in to Article 8 and further require a provision to be added to the governing documents that prohibit the issuer from later opting out. 

The Takeaway  

It bears repeating: the UCC grants priority to a perfected secured creditor over other creditors, including those who hold unperfected security interests. As such, perfecting security interests should always be top of mind for creditors, whether by (1) by properly filing a UCC-1 financing statement or (2) by control, depending, of course,  upon the type of collateral.  

This blog post is not offered, and should not be relied on, as legal advice. You should consult an attorney for advice in specific situations.