Artesian Co. manufactures a wide range of small kitchen appliances, which for the most part it sells directly to retailers. One exception on its customer list is Larchmont, Inc., a family-owned corporation that sells gourmet food and kitchen products at five upscale retail stores scattered throughout South Florida.

Editor's Note: This article originally appeared in the Credit & Collection Manager's Letter, which Credit Today purchased in 2006. This article was a Forum column.

Larchmont recently negotiated a large credit purchase of appliances from Artesian, and in connection with that sale, agreed to grant to Artesian a security interest in the inventory purchased from Artesian. In addition to a promissory note evidencing the debt to Artesian, on June 25, 2001, Larchmont's authorized officer signed a security agreement and a form UCC-1 financing statement describing the collateral.

As a matter of routine, Artesian's credit department then immediately perfected the security interest by filing the financing statement in the office of the Florida Department of State. Several days later the inventory was delivered to Larchmont's main warehouse outside Fort Lauderdale, Florida.

Two weeks later, on July 10, 2001, Larchmont closed a large operating line of credit deal with its bank. In connection with the line of credit, Larchmont granted a security interest in all of its accounts receivable, business equipment, and "existing and after-acquired inventory" at each of its five listed South Florida locations. Unlike Artesian, the bank perfected its security interest by promptly filing a properly executed financing statement in the office of the Secretary of State in Delaware, the state in which Larchmont was incorporated.

If Larchmont subsequently defaults on its loans and ends up in bankruptcy, which of the two perfected liens will have priority? Click below to see our answer and analysis.

Answer and Analysis

Both liens are properly perfected. Artesian's lien is superior, but will remain so only if it is later followed up with a filing in Delaware.

Article 9 of the Uniform Commercial Code governs the creation, perfection, enforcement, and priority of security interests in personal property. Thus any creditor who takes a security interest in goods, such as business equipment or inventory sold on credit, probably is already well familiar with Article 9. A significant revision of Article 9 became effective in 49 of the 50 states on July 1, 2001. One change affecting many creditors is a streamlined procedure for perfecting security interests.

Previously, Article 9 provided for perfection of a security interest in goods by public filing of a financing statement in (and in accordance with the specific law of) the state in which the collateral was located. In the case study, since old Article 9 was still in effect, Artesian correctly followed this procedure with the Larchmont sale by filing in Florida, where Larchmont's stores are located. If Larchmont were a larger or more geographically dispersed retailer buying inventory for ultimate resale in stores located in more than one state, proper perfection of a security interest under old Article 9 would have required Artesian to file financing statements in each of those states--frequently utilizing different forms.

Reduced Filing Burden

Revised Article 9 now reduces this burden by providing for central filing of a new standard form Financing Statement in the debtor's "location" rather than in the location of the collateral. What constitutes the debtor's "location" depends on whether the debtor is a corporation or other registered entity, or an individual/sole proprietorship. In the case of a corporation or a limited liability corporation, the debtor's location is the state where the business is incorporated or organized and registered. For purposes of Article 9 filings, the "location" of a business that is operated as a sole proprietorship is the state of the owner/sole proprietor's principal residence.

In this case, Artesian's public filing of an executed financing statement with the Florida Department of State did properly perfect its security interest and establish its lien priority under old Article 9, given that it was filed prior to July 1, 2001. Under Revised Article 9, however, such financing statements are now to be filed in the buyer/debtor's location--which in this case would be the appropriate public filing office in Delaware, the jurisdiction where Larchmont was incorporated. Therefore, the bank also properly perfected its security interest by filing in Delaware, since it filed after July 1, 2001.

So what becomes of all the currently effective financing statements on file in the "wrong" location, and how will their lien priority be determined? Revised Article 9's comprehensive transition provisions protect a short-term seller/creditor in Artesian's position, at least for the next few years. Under Revised Article 9, Artesian's lien maintains its superiority over the bank's (since it was perfected first in time), but in order to continue the long-term effectiveness and priority of the Florida financing statement, Artesian should ultimately file a new financing statement in Delaware (the state of the debtor corporation's incorporation) in lieu of filing a continuation statement in Florida. The basis of priority for the Delaware filing, then, would be the date of the original financing statement's filing in Florida.

To maintain priority and validity of any long-term security interests currently effective under old Article 9, the second filing (pursuant to Revised Article 9) must be made in the debtor's location before the original financing statement would lapse under the law of the state in which it was filed -- typically five years -- or June 30, 2006, whichever comes earlier. During this transition period, some duplication of effort on the part of creditors may be necessary, but ultimately this change will simplify and reduce the expense associated with perfection of security interests in goods.

Editor's Note: The above article originally appeared in the Credit & Collection Manager's Letter, a newsletter purchased by Credit Today in 2006. This article originally appeared prior to 2000.