Portland Business Journal: Oregon's 2018 Most Admired Companies Oregon Business: 100 Best Companies to work for in Oregon 2019 Oregon Business: 100 Best Green Workplaces in Oregon 2019
Barry  P. Caplan
503.243.1627
 

Purchase Money Security Interests

October 2009

Barry P. Caplan
503.243.1627
Co-Author, Timothy A. Solomon

Published in the NACM Business Credit Journal.

I. Introduction

For many years, I have recommended to clients (and to many credit managers in speeches and articles) that they consider obtaining purchase money security interests (PMSI) in the goods they sell to customers on credit, to more effectively facilitate a financial recovery in the event of nonpayment. Yet all too often, it has been my experience that sellers fail to acquire valid PMSIs until it is too late. Even in good economic times, I frequently hear the same, familiar excuses for inaction: that it is "bad business," or too much trouble, or too expensive.

These are not good economic times! It is increasingly rare to find customers to whom significant sales can be made without credit concerns. In addition, we are currently witnessing an unprecedented condition further underscoring the importance and utility of PMSIs: sellers can no longer rely on a bank continuing a line of credit to a customer, at least not in an amount sufficient to ensure such customer's continued ability to make timely payments. It is no longer reasonable simply to assume that a customer's current bank financing will remain a reliable source of payment going forward.

In such a climate, it is nearly always, if not universally, worth negotiating for PMSIs. Indeed, doing so may be the only prudent basis upon which to extend credit to a financially unstable business, a startup company, or a debtor which has already granted a blanket security interest in its assets to a lender. Even when a customer appears to be financially stable and capable of making payment, a PMSI still may be appropriate if a transaction is sizable enough or if its ability to pay depends on the continuation of a line of credit.

II. Obtaining and Perfecting a Purchase Money Security Interest

Stated simply, a PMSI is a security interest in goods that secures the repayment of the debt owed in connection with the purchase price of the goods. While it is beyond the scope of this article to cover every single aspect of obtaining and perfecting a PMSI, there are a few basic steps that sellers can take to do so without undue cost or difficulty.

First, a seller needs to prepare a form purchase money security agreement to be signed by its customers. If your company does not already have such a form, basic form agreements are readily available and are generally sufficient to protect a seller's interests. In larger transactions, however, it would be best to have a more detailed security agreement prepared by experienced counsel to cover all the elements needed to protect you. To ensure that the buyer is bound, the signed agreement must expressly confirm the existence of the PMSI and grant a security interest in the goods sold. The buyer also must authorize you to file a financing statement to perfect the security interest in the goods themselves and/or in their proceeds.¹  Finally, you must be careful to confirm that the name of the purchaser against which you obtain the PMSI is the legal name of the "debtor" as defined in Article 9 of the UCC.

It may already be your practice to perform UCC searches before you do business with a new customer or before you approve large sale transactions with an existing customer. In any event, you should perform such a search and, if you learn your customer has already granted a general security interest in its equipment, inventory, or assets, to make your PMSI effective and have priority over conflicting security interests, you must (1) perfect your security interest in the collateral (by filing a UCC-1 financing statement) before the debtor receives possession of the goods or within 20 days thereafter, or, (2) in the case of inventory, you must (a) perfect the PMSI before the seller receives the goods and, (b) if a conflicting security interest exists, (i) you must also send an authenticated notification to the holder of the conflicting security interest, (ii) the holder of the conflicting security interest must receive the notification within five years before the debtor receives possession of the inventory, and (iii) the notification must state that you have or expect to acquire a PMSI in the inventory and must describe the inventory. UCC 9-324.

Because a PMSI is often intended to provide a security interest in both the goods sold at the time the PMSI is granted and those sold in the future, you should make sure the description of the collateral is adequate, though it need not be overly detailed. For example, the description could read simply as "all inventory of the (debtor company name) acquired from (your company name) or hereafter acquired from (your company name), as well as the proceeds and product from the sale of such inventory."

Upon properly filing a financing statement and giving notice to an existing lender before delivering of the goods, your PMSI will have "squeezed in" ahead of the lender's security interest.

III. Additional Benefits; Issues; Remedies

As discussed above, prior notice to the lender or holder of a conflicting security interest in inventory prevents the security interest of the prior secured party from attaching to your goods and destroying PMSI status. Proper perfection and notice enable you to jump ahead of earlier secured parties to the first position as to your goods and the proceeds thereof. A valid and perfected PMSI also has other virtues, such as putting you in a position to receive notice from your customer's bank if there is a default and it alerts other potential suppliers of your security interest in the goods you sold and their proceeds.

Because most grants of security apply not only to the goods themselves (which in the event of default would allow recovery of those goods if still owned by the debtor), but also to the proceeds from the buyer's resale of such goods, issues often arise regarding traceability and commingling of proceeds in debtor's general bank accounts. If your customer handles proceeds of your collateral in a manner that makes the funds impossible to trace, you may lose the right to recover such proceeds. Because of such risks, it may be wise to consider negotiating inter-creditor agreements with the lender or other competing secured creditors to arrive at a fair arrangement for sharing proceeds if not traceable.

In addition to foreclosure on collateral, there is another practical option that often will make sense in the event of nonpayment. A secured creditor with a PMSI is not limited to the remedy of foreclosure. Instead, it may sue on the debt, and upon obtaining a judgment may then levy execution on its own collateral and retain its priority under the UCC-1 filing. UCC 9-601(e). In some cases this procedure allows for a quicker, less expensive remedy while retaining the benefit of a security interest.

IV. Practical Considerations

Customers have choices, and some may prefer to purchase from vendors that make the sales process an "easy" one. Accordingly, the best time to ask for a PMSI agreement may be when a customer first contacts you, needs your products, and may be willing to agree to your standard sales terms.

One thing to keep in mind is that customers unwilling to agree to a PMSI are often the very customers you will have difficulty collecting from in the future. Requesting a PMSI thus provides the further benefit of making a subjective decision part of the objective criteria under which you make your initial credit decision. After a sufficient amount of time and successful collections, you may determine that a particular customer is strong enough financially to be permitted to warrant an extension of credit without a PMSI agreement. But in the first instance, the best method of selling to marginally qualified customers is in accordance with the practices outlined in this article.

V. Conclusion

If Dickens were alive today, he would have begun A Tale of Two Cities with only half of the first sentence: "it is the worst of times." Nevertheless, the economy appears to be stabilizing and future sales opportunities are looking stronger than they have in some time.

But even if the economy is once again moving in a positive direction, sellers should heed the lessons of the recent economic contraction, and should closely examine whether in fact their past practices have really been effective. In many instances, selling to customers on an unsecured basis is a dangerous practice even in a favorable economy. It is well worth considering when, how, and to what extent you should use PMSIs in the future to better protect yourselves against your customer's defaults.

___________________

Barry P. Caplan is a partner at Sussman Shank LLP where he specializes in commercial law and business bankruptcy. He may be reached by email at: barry@sussmanshank.com.

Timothy A. Solomon is an attorney at Leonard Law Group.  He can be reached at: tsolomon@LLG-LLC.com

___________________

¹  The procedures for preparing and filing financing statements under the Uniform Commercial Code (UCC) and the logistics of conducting UCC searches are beyond the scope of this Article, but such activities can quickly and easily be accomplished by experienced UCC counsel.

 

Related Practice Areas

Business Restructuring & Bankruptcy

Return to Articles