How should collateral be described in a “blanket” security agreement? The goal is to include all of the debtor’s personal property. But using the term “all assets” or a similar phrase in a collateral description can be either a disaster; or a lifesaver for lenders and their counsel. Matter of Sterling United, Inc., 2016 WL 7436608 (2d Cir 12/22/16) is an object lesson on how language which is legally necessary to expand the term “all assets” can create controversy if carelessly drafted.

Some background:  Uniform Commercial Code Article 9 defines a list of generic types of collateral which, if all of them are used in a collateral description, will create a lien on all of the debtor’s personal property. These generic types are: (i) goods (which includes both fixtures, equipment and inventory, manufactured homes and crops); (ii) accounts; (iii) chattel paper; (iv) documents; (v) instruments; (vi) investment property; (vii) letter of credit rights; (viii) deposit accounts; (ix) money; and (x) general intangibles (note that special rules apply to commercial tort claims and consumer transactions).

UCC §9-108(b)(2) provides that a collateral description that simply refers to a type defined in the UCC “reasonably identifies” collateral of that type without the need to be any more specific. But section 9-108(c) states that a supergeneric collateral description, such as “all the debtor’s assets” does not reasonable identify the collateral. As a result, a security agreement which describes the collateral simply as “all assets of the debtor” creates no security interest at all. Adding to the confusion, UCC § 9504(2) validates the use of a supergeneric description in a financing statement. But unless a security interest is created in the first place by a valid security agreement, a financing statement is meaningless.  As a result of these rules, it is legally necessary for the description of collateral in a security agreement to be more specific, even if the financing statement need not be. Also, more specific lists of sub-types or items of collateral make the security agreement more easily understood by the parties and by judges. But beware; careless drafting of this extra language can give rise to disputes.

In Sterling United, the collateral description appearing in both the security agreement and financing statement was as follows:

All assets of the Debtor including, but not limited to, any and all equipment, fixtures, inventory, accounts, chattel paper, documents, instruments, investment property, general intangibles, letter-of-credit rights and deposit accounts now owned and hereafter acquired by Debtor and located at or relating to the operation of the premises at 100 River Rock Drive, Suite 304, Buffalo, New York . . . .

Years after the security agreement was signed and the UCC-1 was filed, the debtor moved its operations to another address. The UCC-1 was amended to change the debtor’s address, but was not amended to change the above collateral description (until too late, less than 90 days before the debtor’s bankruptcy filing). The bankruptcy trustee sought to avoid the Bank’s security interest on the grounds that the security agreement and financing statement did not reasonable identify the collateral, due to the change in its location, and that the discrepancy in the address made the financing statement  “seriously misleading” with the meaning of UCC § 9506(a).

The Second Circuit treated the question as one of perfection, but as explained above the issue was also whether a security interest had been created in the first place. The Court’s reasoning focused on the phrase “including but not limited to . . . .” The opinion contains a useful collection of authority as to interpretation of that phrase, which appears in many contracts. But the real ambiguity in the above description is whether the phrase “and located at” directly modifies the “all assets” language or whether it is merely part of the list of specific assets which followed “including but not limited to.” The Court, without diagramming the sentence, concluded that the former interpretation “does not make sense.” The Court then concluded that the use of the term “all assets” prevented the financing statement from being “seriously misleading.”

Nobody wants the validity or perfection of their security interest to hang on a nuance of grammar. The grammatical problem only arose when the drafter decided to include in the collateral description a legally unnecessary reference to a specific location. Even if there is a good non-legal reason to refer to locations in a collateral description, the phrase “all assets of the debtor, wherever located, including but not limited to . . . “would have avoided the litigation that would up at the Second Circuit Court of Appeals.

These materials were prepared for the Commercial Transactions Committee by Dean T. Kirby, Jr., Kirby & McGuinn, A P.C., San Diego. Editorial contributions were provided by Committee members.

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