Several legal commentators have weighed in on a recent 6th Circuit U.S. Court of Appeals decision that held that the term “proceeds” in the collateral description on a UCC financing statement did not include the debtor’s accounts receivable. We disagree with those who have suggested that the court held that accounts would never be considered proceeds of collateral. Our view is that the court acted in accordance with the letter and spirit of UCC Article 9 by refusing to ignore the mistake the lender made in its financing statement and in finding that a collateral description covering only proceeds of certain goods does not perfect a security interest in all of debtor’s accounts.
In 1st Source Bank v. Wilson Bank & Trust, et al., the court considered the priority claims of the creditor parties. 1st Source had a security interest in the debtor’s tractors and/or trailers, accounts, and in the proceeds from the agreed-upon collateral. The relevant financing statements described the collateral as the tractors and/or trailers and “all proceeds thereof, including rental and/or lease receipts.” The financing statement collateral description did not include the terms “accounts” or “accounts receivables” or anything similar. Wilson and the other defendants subsequently filed valid financing statements which included the term “all accounts receivable now outstanding or hereafter arising.” After the debtors defaulted, defendants took possession of the accounts receivable and 1st Source argued that it had first priority in those accounts based upon its earlier filing
The court held that, under Tennessee law, 1st Source did not have a perfected security interest in the debtor’s accounts receivable because its financing statements were not sufficient to put third parties on notice that it had a security interest in the debtor’s accounts. By listing various types of collateral that were subject to its security interest on its financing statement, 1st Source was held to have excluded other types of collateral that were not listed, including the accounts receivable.
UCC Article 9 clearly indicates that proceeds may consist of accounts. Here, the court held that the because Article 9 defines both the general term “proceeds” and the specific term “accounts,” to hold that proceedsautomatically include accounts would wrongly subsume the UCC’s separate, specific definition of “accounts.” This should not be interpreted (as has been done by some) to mean that the court held that proceeds can never include accounts.
It is not at all surprising that collateral consisting of manufacturing equipment and its proceeds does not include all of the debtor’s accounts, even given the fact that the use of equipment adds value to inventory. The 1st Source analysis is somewhat harder because the trucks in question may have been inventory and rental or lease receipts, as suggested by the collateral description in the case, are indeed proceeds. However, even if certain accounts are proceeds, all accounts are not proceeds so the descriptor “proceeds” is necessarily inadequate to cover all accounts.
This case was about a lender that made a mistake in its financing statement. When its filing mistake caused it to not get the benefit of the collateral that it had bargained for, the lender tried to salvage its position by arguing that its mistake should not matter. The court followed precedent by citing several cases in which courts held that income generated from the use of (rather than the disposition of) collateral does not constitute “proceeds” under Article 9. Because the debtor earned income using the collateral equipment without a loss or disposition of its interest in the collateral, the court held that the income (held as accounts receivable) should not be considered Article 9 proceeds.
The lesson from this case is nothing new. Lenders should make sure that their financing statements specifically name accounts as part of the collateral description; the courts are not likely to correct oversights that would harm other creditors who had relied upon the filings.