In a typical secured credit facility, a lender makes a loan to a borrower secured by all assets of the borrower, including property acquired after the closing of the loan. Upon the closing, the lender files a UCC financing statement in the appropriate jurisdiction to ensure that it has a perfected, first-priority lien in the collateral. The lender might be surprised to learn that its perfected security interest in after-acquired property may subsequently become junior to a purchase-money security interest (PMSI) held by a seller or other party that is financing the borrower's purchase of inventory, equipment, or other assets.
What is special about a PMSI?
A creditor that has a PMSI has the ability to gain priority over (or to “prime”) previously perfected security interests. The priority afforded to PMSIs is an exception to the “first-to-file” rule of UCC 9-322(a), which governs the priority of most security interests.
What is a PMSI?
In short, a PMSI is a security interest in goods securing credit extended to enable the debtor to acquire or use the goods. A security interest granted by a buyer of goods to the seller thereof that secures the deferred payment of the purchase price would generally be a PMSI, as would a security interest granted by a buyer to a lender that advances funds to the buyer to enable the buyer to buy goods from a seller to secure such advances.
To constitute a PMSI, the UCC requires a “close nexus” between the acquisition of collateral and the secured obligation. A delay in time between the acquisition of the collateral and the securing of the related indebtedness will prevent a finding of a “close nexus.” For example, if a buyer purchases goods with cash then at a later date obtains a loan from a lender and grants a security interest in those goods to secure the loan, the lender’s security interest would not constitute a PMSI. A “close nexus” generally exists for ancillary obligations, such as interest, default charges, installation charges, insurance, and other “obligations for expenses incurred in connection with the acquiring rights in the collateral.”
How does a creditor obtain a PMSI?
In order to obtain a PMSI, the buyer must execute a security agreement granting a security interest in the goods sold in favor of the creditor (be it the seller or a lender). The creditor must perfect its security interest in the goods, which is usually done by filing a UCC financing statement in the appropriate jurisdiction (which in most cases is the jurisdiction of the buyer’s organization).
What is the priority of a PMSI?
Under UCC 9-324(a), in the case of a PMSI in goods other than inventory or livestock, a creditor that perfects its PMSI before or within 20 days after the buyer receives possession of the collateral will gain priority over security interests that were perfected prior to the perfection of the creditor’s PMSI. This is true even if the PMSI holder knows of the earlier secured parties and earlier filings covering the collateral under an after-acquired property clause. A PMSI that is not perfected within this time period will have priority determined by the normal “first-to-file” rule of UCC 9-322(a).
The UCC treats PMSIs in inventory differently from PMSIs in other types of collateral. In Part 2 later this month, we will discuss PMSIs in inventory and consigned goods, and look at a few ways that a secured lender may want to address PMSIs in its loan documents.