Good intentions and planning are not enough

Article 9 requires that for a security interest to be created, value must be given, the debtor must have rights in the collateral and, unless the secured party has possession of or control over the collateral, the debtor must authenticate a security agreement describing the collateral. UCC Section 9-203(b). These requirements are easily satisfied. But mistakes get made and sometimes a signed security agreement cannot be found.

In some cases, secured parties are able to find something signed by the debtor that smacks of a security agreement. Prior to 2001, when financing statements were signed, secured parties were sometimes able to rely on the signed financing statement along with other loan documents under the “composite document rule.” Now that financing statement are no longer signed, it is harder to find a substitute for a properly executed security agreement. Nevertheless, secured parties sometimes get lucky, as did Wachovia (now Wells Fargo) in In re WL Homes, LLC, 2013 WL 4019397 (3d Cir. 2013).

In that case, the borrower intended to pledge a deposit account owned by its wholly-owned subsidiary to secure its loan. The relevant loan agreement provision provided that the borrower would maintain its subsidiary’sprimary deposit account with lender, the deposit account would maintain a minimum balance and “Borrower grants to Lender a security interest in the [deposit account].” The loan agreement was signed by the borrower’s CFO, who also happened to be the President of the subsidiary. Based on the signer’s status as a dual agent of both the borrower and the subsidiary, and the broad power and authority afforded the subsidiary’s President under the subsidiary’s bylaws, the court imputed knowledge and consent to the subsidiary and validated the security interest.

Other intended secured parties are not so fortunate, as was the case in Terry J. Nosan Declaration of Trust dated 1/15/93, et al v. GS Cleantech Corporation, et al, Docket No. 311420 (Mich. Ct. App. June 17, 2014). The salient, but simplified, facts are as follows. The plaintiffs provided a “bridge loan” to the defendants to provide additional financing to complete the construction of various facilities to extract corn oil for bio-fuels. The defendants already had senior secured loans and the senior lenders required a subordination agreement. The agreement subordinated the plaintiffs’ loans but also provided that absent a senior debt default certain limited monthly payments could be made on the subordinated debt and, in addition, if there were a default under the bridge loan, the plaintiffs would be entitled to “receive” certain specified percentages of net cash flows from specified facilities. The borrower was permitted to pledge such net cash flows to plaintiffs but otherwise the subordinated loan would be unsecured. A guaranty of the subordinated loan noted that the subordinated loan “shall be guaranteed by a pledge of the net cash flows. . . .”

Unfortunately for the plaintiffs, when it came to proving their security interest in court, the judge stated that “I can’t find where the borrower ever signed a document that gives a security interest to any of the plaintiffs anywhere, let alone in your claim for cash flow.” The guaranty agreement was signed by the guarantors and not by the borrower.

The Court of Appeals, applying New Jersey’s UCC 9-203, found that the guaranty and subordination agreement were not signed by the borrower and in any event were limited to reflecting the mere understanding that a pledge of the net cash flows was authorized. The lack of a debtor signature was fatal to the plaintiffs’ cause, notwithstanding the parties’ evident expectation that a security interest would be granted.