A Mis-indexed UCC-1 Financing Statement Remains Valid and Prior to a Subsequent FilingPublications - Client Alert | March 30, 2017
The United States Bankruptcy Court for the Northern District of West Virginia recently held that a UCC 1 financing statement properly submitted to, but mis indexed by, the UCC filing office was effective and prior to a subsequently filed financing statement. As a result of the holding, a subsequent creditor of the debtor, which filed a financing statement after the prior but mis indexed financing statement of another creditor, was second in priority to the prior mis indexed filing, despite the subsequent creditor’s reliance on a UCC search that did not disclose the mis indexed financing statement. See Davis Trust Co. v. Citizens Bank of W. Va., Inc. (In re Reckart Equip. Co.), No. 12-BK-670, 2017 WL 943909 (Bankr. N.D. W.Va. Mar. 9, 2017).
While the conclusion of the Davis Trust v. Citizens Bank decision may not provide comfort to UCC searchers, the decision appears correctly decided under applicable UCC provisions.
Citizens Bank of West Virginia (“Citizens Bank”) made two loans to Reckart Equipment Co., Inc. (the “Debtor”) in late 2007. At the same time, Citizens Bank also made a separate loan to an affiliate of the Debtor, DSTS, Inc. In January 2008, Citizens Bank sent two UCC-1 financing statements to the West Virginia Secretary of State (the “SOS”) in a single envelope: one in proper form reflecting the Debtor as debtor and providing for a blanket lien on all the Debtor’s assets (the “2008 Financing Statement”), and the other reflecting DSTS, Inc. as debtor. Citizens Bank included in the envelope a single check for $10.00 that noted “Recording Fees Reckart Equipment Company” in the memo line. The SOS received both financing statements on January 10, 2008, stamped both financing statements with the same filing number, cashed the check and indexed both financing statements under the debtor name for DSTS, Inc.1
In May 2009, Davis Trust Company (“Davis Trust”) made a loan to the Debtor and filed its own UCC-1 financing statement against the Debtor (the “Davis Trust Financing Statement”). Before making the loan, Davis Trust conducted a UCC search under the Debtor’s name, but the search did not reveal Citizens Bank’s 2008 Financing Statement in all the Debtor’s property because such filing had been mis-indexed by the SOS.
In September 2009, after Davis Trust made its loan to the Debtor, Citizens Bank discovered that its 2008 Financing Statement against the Debtor was not reflected in the list of financing statements under the Debtor’s name. Citizens Bank advised the SOS that the 2008 Financing Statement had been mis-indexed by the SOS. In response, the SOS generated a new filing number for the 2008 Financing Statement on September 2, 2009 and backdated it to January 10, 2008.2
The Debtor subsequently filed bankruptcy in May 2012. Each of Citizens Bank and Davis Trust argued that its perfected security interest in property of the Debtor was prior to the other, and each sued the office of the SOS for negligence in mis indexing Citizens Bank’s 2008 Financing Statement.
The bankruptcy court determined that Citizens Bank’s 2008 Financing Statement against the Debtor was prior to the Davis Trust Financing Statement, notwithstanding that the 2008 Financing Statement was incorrectly indexed by the SOS. In so holding, the court cited Sections 46-9-516(d) and 46-9 517 of the West Virginia UCC. Section 46-9-516(d) provides, in pertinent part, “A record that is communicated to the filing office with tender of the filing fee, but which the filing office refuses to accept for a reason other than [insufficient information on the financing statement,] is effective as a filed record.” Section 46-9-517 further provides, “The failure of the filing office to index a record correctly does not affect the effectiveness of the filed record.” In relying on these two UCC Sections, the court reasoned:
The final UCC-1 financing statement deserving consideration is the 2008 Financing Statement. Citizens submitted this financing statement by mail to the [SOS]. There is no dispute as to whether this was a proper medium of delivery. It is also undisputed that the 2008 Financing Statement provided the names of the debtor and the secured party and indicated the collateral covered by the financing statement. Thus, the 2008 Financing Statement was properly filed so long as it was also accompanied by a sufficient filing fee. In this case, Citizens submitted two UCC-1s, one relating to the Debtor and another relating to DSTS, Inc., and tendered one $10 check. As the filing fee for a UCC 1 is $10, it is clear that Citizens did not submit sufficient funds to cover both financing statements. However, Citizens designated the single check for the Debtor’s filing fee by writing “Recording Fee Reckart Equipment Company” on the memo line of the check. Thus, Citizens satisfied all of the necessary filing requirements such that the 2008 Financing Statement is effective as of the filing date even if the [SOS] refused to accept the record. W. Va. Code § 46-9-516(d). Moreover, because Article 9 provides that the “failure of the filing office to index a record correctly does not affect the effectiveness of the filed record,” the 2008 Financing Statement is effective if the [SOS] accepted and improperly indexed the record. W. Va. Code § 46-9-516.
Davis Trust, 2017 WL943909, at *8. Therefore, the court determined that Citizens Bank held a perfected security interest in the Debtor’s assets “no later than January 10, 2008.” Id.3
In response to the negligence actions against the SOS, the SOS filed a motion for summary judgment asserting that Citizens Bank held a prior perfected security interest and was thus not harmed by the mis- indexing. The SOS further asserted in its motion for summary judgment, among other things, that Davis Trust’s claims of negligence against the SOS were barred by (i) the Eleventh Amendment provisions insulating states from certain suits and liabilities, (ii) qualified immunity insulating states from suits in connection with decision making authority and (iii) the two-year statute of limitations applicable to negligence claims.
While the bankruptcy court did not have jurisdiction to issue a final order respecting the claims against the SOS, it did have the authority to issue a recommendation to the district court. The bankruptcy court recommended that the district court deny the SOS’s motion for summary judgment, which would leave the issues against the SOS open for a subsequent determination at trial or otherwise. The bankruptcy court reasoned:
In this case, not the Eleventh Amendment, constitutional immunity, or qualified immunity offer[s] any protection to the [SOS] at this point. …. [I]t is clear that the conduct of the [SOS] was neither legislative nor judicial in nature. Therefore, she is only protected by qualified immunity if her conduct was not in violation of a clearly established law of which a reasonable official would have known. However, Article 9 provides a series of bright line rules that apply to the [SOS] in maintaining a filing system. Specifically, with respect to a record filed with the [SOS], W. Va. Code § 46-9-19(a) provides that the [SOS] shall:
(1) Assign a unique number to the filed record;
(2) Create a record that bears the number assigned to the filed record and the date and time of the filing;
(3) Maintain the filed record for public inspection; and
(4) Index the field record in accordance with [other provisions of Article 9].
Moreover, § 46-9-519(c) requires the [SOS] to “index an initial financing statement according to the name of the debtor.[”] Additionally, § 46-9-520 sets forth two additional requirements for the [SOS]. It must “refuse to accept a record for filing for a reason set forth in § 9-516(b)” and it must accept a record for filing if the record complies with § 9-516(b). As explained above, § 46 9 516(b) provides that a record is properly filed if it contains sufficient information, is communicated to the filing office in a medium it accepts, and is accompanied by a sufficient filing fee. Thus, Article 9 grants no discretion to the [SOS] for determining when a financing statement should be rejected or accepted.
Id. at *10 11. The court further reasoned that the SOS’ action in engaging in lengthy litigation without seeking dismissal on the basis of its immunity created a question whether the SOS waived its immunity.
The bankruptcy court also recommended the district court deny the SOS’ argument that Davis Trust’s claims were barred by the two-year statute of limitations applicable to negligence claims. The bankruptcy court determined that the two-year statute of limitations should not start running until the time the parties discovered the indexing error and the related harm. The court further explained that the record developed thus far in the case concerning such discovery by the parties did not support a finding that the statute of limitations had run.
Given that the 2008 Financing Statement was completed in a correct form and correctly submitted by Citizens Bank to the SOS, and given the court’s determination that the filing fee related to the 2008 Financing Statement, the Davis Trust v. Citizens Bank decision appears correctly decided, despite the fact that Davis Trust relied on an inaccurate record.4 Under the UCC sections cited by the court, an effective UCC “filing” can exist upon proper presentment of a UCC filing in correct form to a UCC filing office, with the correct filing fee. See also U.C.C. § 9-516(a) (West 2017) (“Except as otherwise provided in subsection (b), communication of a record to a filing office and tender of the filing fee or acceptance of the record by the filing office constitutes filing.”). As noted in U.C.C. § 9-517, official comment 2 (West 2017), “this section imposes the risk of filing office error on those who search the files rather than on those who file.” Although arguments can be made that UCC filers are in a better position to know about and verify the accuracy of their UCC filings, as opposed to UCC searchers who may unknowingly receive inaccurate records, the policy reason underlying Section 9 517 is to avoid making UCC filers responsible for a filing office’s mistakes.5
A post-filing UCC search could be performed by UCC filers to verify the proper filing and indexing of a UCC filing. Although UCC filers often obtain copies of file stamped financing statements, a file stamped copy may not reflect how the filing is indexed in the records of the filing office and whether it is indexed under the correct debtor name. Despite the holding in the Davis Trust v. Citizens Bank case in favor of the UCC filer, a post filing search could avoid potential priority contests with other creditors, additional scrutiny that such a contest could bring on the propriety of a UCC filing, legal fees related to any such dispute and potential pressure to settle for less than the recovery would otherwise be under a proper filing.
Based on the Davis Trust v. Citizens Bank decision, lenders and other creditors should clearly communicate their filing instructions to the related UCC filing office, especially if the contents of a mailing include more than one UCC filing, and include a sufficient amount for all applicable filing fees.6
In addition, depending on further developments in the case, it may also be possible to assert claims against a filing office for mis-indexing a UCC-financing statement. However, the existence of such claims, if any, may depend on further developments in the case, including any appeals, and any such claims could be very narrow or very fact specific.7
Last, it also appears worth noting that the Davis Trust v. Citizens Bank case emphasizes the need for lenders and other creditors to obtain a clear representation from a debtor that pledged collateral is free and clear of all liens and encumbrances. While such a representation may cause some debtors to disclose other liens, it is also important to recognize that such a representation may be wrong. While many debtors may be honest, there are of course exceptions. Some debtors get confused, some debtors make honest mistakes, some debtors simply do not read loan documents closely, and some debtors lie. If wrong, a debtor’s representation that collateral is unencumbered will not provide a creditor with any rights or protections against a competing creditor (or a bankruptcy trustee for a debtor) with a prior security interest or superior rights. However, despite the foregoing caveats, there is certainly no harm in requiring such a representation from a debtor if an extension of credit is conditioned on a first priority or exclusive lien in a debtor’s assets.
For additional information, please contact your Kutak Rock LLP attorney, a member of our Bankruptcy group, or the author of this client alert.
1 The SOS filing fee for each financing statement was $10.00. Thus, Citizens Bank’s $10.00 check was sufficient to cover the filing fee for only one financing statement. As addressed below, the court held that the $10.00 check related to the 2008 Financing Statement reflecting the Debtor as debtor.
2 Although the SOS backdated the 2008 Financing Statement, the SOS act of backdating the 2008 Financing Statement was not discussed as a determining factor in the court’s decision. The correction of a filing office’s mistakes is provided for in some filing office’s rules and regulations. The correction may also enable subsequent UCC searchers to locate the 2008 Financing Statement. In addition, Citizens Bank filed additional financing statements against the Debtor, but those financing statements are not directly relevant to this memorandum and are not discussed herein.
3 The court did not discuss the effectiveness of the Citizens Bank UCC-1 financing statement filed against the Debtor’s affiliate, DSTS, Inc. because this filing was not at issue. Given the court’s holding that the $10.00 filing fee was submitted for the 2008 Financing Statement, it would appear that no filing fee was submitted for the UCC-1 relating to DSTS, Inc. However, perhaps this UCC-1 remains effective based on the “or acceptance of the record by the filing office” language in U.C.C. § 9-516(a) (West 2017) (“Except as otherwise provided in subsection (b), communication of a record to a filing office and tender of the filing fee or acceptance of the record by the filing office constitutes filing.”).
4 The holding in the Davis Trust v. Citizens Bank case is also consistent with at least one other ruling. See, e.g., The Commercial & Sav. Bank v. Wells Fargo Bank Nat’l Ass’n, as indenture trustee (In re Twin City Hospital), Adv. No.-10 6130 (Bankr. N.D. Ohio Apr. 22, 2011).
5 This is also not an instance in which the filing office wrongfully rejected a proper UCC filing under U.C.C. § 9-516(d) (West 2017) (which filing may be effective “except as against a purchaser of the collateral which gives value in reasonable reliance upon the absence of the record from the files.”). See U.C.C. § 9-516(d), official comment 3 and Section 9-520(b) (requiring the filing office to provide prompt notice of a refusal to accept a filing). In the circumstance presented by Section 9-516(d), the UCC filer should be aware of the filing office’s rejection of the UCC filing and the absence of any record in the filing office’s UCC files. A UCC filer that is aware its filing has been rejected thus assumes the risk of losing priority to a subsequent party under Section 9-516(d) who reasonably relies on the UCC record. In the Davis Trust v. Citizens Bank case, on the other hand, the filing office accepted a proper filing for purposes of UCC Section 9-517, but mis-indexed the filing.
6 While the court in the Davis Trust v. Citizens Bank case held that Citizens Bank’s $10.00 check related to the 2008 Financing Statement, it is possible that a different court could have concluded otherwise, or that the method of presenting the 2008 Financing Statement to the filing office raised fact issues for trial, or that the single $10.00 check presented for two filings (which together cost $20.00) constituted negligence on the part of the UCC filer or caused or contributed to the filing office’s mistake. The bankruptcy court in the In re Twin City Hospital case referred to in footnote 4 above, for example, noted that “[i]f the first to file errs in a manner that causes another party to miss a financing statement, courts tend to direct the fallout on the filer,” but found on the facts presented “[t]here is no evidence that defendant [as the filer of the mis-indexed filing] erred in any manner.”
7 Non-uniform UCC provisions in certain states may also limit the liability of a UCC filing office. See, e.g., Kan. Stat. Ann. § 84-9-523(f) (West 2017) (“Except with respect to willful misconduct, the state, counties and filing officers are immune from liability for damages resulting from errors or omissions in information supplied pursuant to this act.”).