Collateral descriptions in financing statements are often an afterthought for secured creditors, and are frequently prepared in the simplest way possible, sometimes due to carelessness, sometimes because the debtor wishes to maintain its privacy by not disclosing specific pieces of collateral or investments, and sometimes due to administrative simplicity to minimize the cost and hassle of future amendments to financing statements in deals where the debtor regularly exchanges collateral of the same type. For years, secured creditors benefited from cases in which courts found that the Uniform Commercial Code does not require collateral descriptions in financing statements to be perfect, so long as the financing statements give enough notice as to the approximate nature of the collateral to cause subsequent creditors to make further inquiry with the debtor. Two recent decisions suggest that some courts may be taking a stricter approach with collateral descriptions and possibly limiting the further inquiry doctrine, serving as a warning to secured creditors to take care to describe their collateral with as much specificity as possible to ensure that a bankruptcy court will not demote a secured creditor to unsecured status, or allow another creditor to jump ahead of the secured creditor in priority.

In the case of First Midwest Bank v. Reinbold (In re 180 Equip., LLC), the secured creditor filed a financing statement describing its collateral as “all collateral described in the First Amended and Restated Security Agreement dated March 9, 2015, between Debtor and Secured Party.” The bank did not attach a copy of the security agreement to the financing statement, and the debtor ultimately filed for bankruptcy. The court ultimately determined that the identity of the collateral was not objectively determinable from the description in the financing statement, and that the shorthand incorporation by reference of the security agreement, without any additional reference to collateral type in the financing statement, was insufficient to describe the collateral, and did not put third parties on notice as to the specific items of collateral themselves, or of the kinds of types of property subject to the security interest. Consequently, the bankruptcy trustee was able to avoid the bank’s lien on the debtor’s property.

Around the time that the First Midwest case was decided, a different court further limited the “further inquiry” doctrine in a case arising from the Puerto Rico bankruptcy. In In re Fin. Oversight and Mgmt. Bd. for Puerto Rico, the court set aside the security interest of the secured creditors where subsequent creditors would be required to extend their searches beyond the local filing clerk’s office. In the Puerto Rico case, bondholders filed a financing statement against a debtor describing the collateral as “the pledged property described in the Security Agreement attached as Exhibit A hereto and by this reference made part hereof.” The 2008 Financing Statement attached the security agreement, but the security agreement did not define or describe the “pledged property,” other than noting that such property was described in a certain pension funding bond resolution. The resolution was publicly available electronically on the debtor’s website, among other locations, but neither the 2008 Financing Statement nor the security agreement noted the resolution’s location. The First Circuit held that because the collateral was described by reference in a document located outside the UCC filing office, without listing the document’s location in the 2008 Financing Statement, an interested party would not have received notice of the collateral at issue. The court further held that “requiring interested parties to contact debtors at their own expense about encumbered collateral, with no guarantee of a timely or accurate answer, would run counter to the notice purpose of the UCC.”

Secured creditors should review their security agreements and financing statements carefully to ensure that the collateral is described with sufficient detail. As a best practice, if a secured creditor wants certainty that its financing statement collateral description will survive the scrutiny of a bankruptcy court or challenge by another creditor, they should either take care to describe the collateral as thoroughly as they do in their security agreement, or if they have a borrower who is focused on maintaining his or its privacy, request that the debtor transfer his or its property to a newly formed special purpose limited liability company where the creditor can file a financing statement describing the collateral as “all assets of the debtor.”