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Financing Statement Filed Without Debtor's Authorization

By Rudolph J. Di Massa Jr. and Chad E. Odhner
November 6, 2015
The Legal Intelligencer

Financing Statement Filed Without Debtor's Authorization

By Rudolph J. Di Massa Jr. and Chad E. Odhner
November 6, 2015
The Legal Intelligencer

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Skip Di Massa
Rudolph J. Di Massa, Jr.
Chad Odhner
Chad E. Odhner

Under the Uniform Commercial Code (UCC), a secured party can perfect its lien on certain of a debtor's assets by the filing of a UCC-1 financing statement. However, Section 9-509 of the UCC provides that a party may file such a financing statement only if the debtor authorizes the filing: either expressly in an authenticated record or, more commonly, by executing a security agreement. The UCC does not specify when a debtor must provide such authorization, but the U.S. Bankruptcy Court for the Southern District of New York recently held that a debtor's written authorization need not precede the filing of a financing statement. In In re The Adoni Group, 530 B.R. 592 (Bankr. S.D.N.Y. 2015), the secured party filed a financing statement before the parties had executed a security agreement, and without the debtor having otherwise authorized the filing in writing. However, because the debtor ultimately executed a security agreement, the court held that the debtor effectively ratified the filing and that the secured party's lien was thus validly perfected. In so holding, the court clarified that the term "authorize," as used in Section 9-509 of the UCC, encompasses forward-looking authorization as well as retroactive ratification of a filed financing statement.

The Facts

Capital Business Credit LLC filed a UCC-1 financing statement with New York's Department of State, asserting a blanket lien against substantially all of the assets of The Adoni Group Inc. (the debtor). At the time of the filing, the debtor had not signed a security agreement nor had the debtor otherwise provided Capital with written authorization to file the financing statement.

The day after Capital filed its financing statement, the parties entered into a factoring agreement, pursuant to which Capital made formula-based loans to the debtor, and the debtor granted Capital a security interest in its accounts receivable, contract rights, software, cash deposits and the like. The factoring agreement contained standard authorization language appointing Capital as the debtor's "attorney-in-fact" and authorizing Capital to sign and file a financing statement on the debtor's behalf. A month later, the parties entered into an inventory security agreement, which granted Capital a lien against the debtor's current and future inventory. By its terms, the inventory security agreement was "part of" and "supplementary to" the factoring agreement. Taken together, the two agreements (the security agreements) granted Capital a lien against substantially all of the debtor's assets and authorized Capital to file a financing statement to that effect.

During the following year, the debtor's financial situation deteriorated to the point that the debtor's unpaid creditors filed an involuntary bankruptcy petition against the debtor. The committee of unsecured creditors in the bankruptcy case brought an adversary proceeding against Capital, seeking to avoid Capital's security interest in the debtor's assets on the grounds that the financing statement was void as filed. The committee argued that, because the debtor had not signed or otherwise provided written authorization for the financing statement at or before the time the financing statement was filed, the filing was invalid and Capital's security interest was unperfected as a result. In response, Capital moved for summary judgment, arguing that the debtor's subsequent execution of the security agreements automatically ratified the financing statement as a matter of law, thus perfecting Capital's lien. The committee conceded that a financing statement could be ratified under common-law principles, but argued that ratification is not automatic under the UCC and that a determination of common-law ratification involved factual questions that would have to be resolved at trial.

The Court's Analysis

Noting that no other court has addressed the question of when a debtor's authorization must be provided, the court began its analysis by highlighting the relevant provisions of New York's UCC. Specifically, Section 9-509 of the UCC provides: "(a) A person may file an initial financing statement ... only if ... the debtor authorizes the filing in an authenticated record or ... (b) By authenticating ... a security agreement, a debtor ... authorizes the filing of an initial financing statement." According to the court, at issue was whether Subsection 509(b) contemplated authorization of a filing by subsequent authentication of a security agreement. Thus, the court looked next to the meaning of the word "authorizes" as used in Section 509.

Because the UCC does not define the word "authorize," the court explored its common meanings. The court acknowledged that "authorize" does have a forward-looking meaning: "to empower or give permission for an act to occur." This forward-looking meaning, the court conceded, would be consistent with the committee's argument that a debtor's authorization must temporally precede a secured party's filing. However, the court noted that the word authorize is also commonly used in a retroactive sense, which encompasses the sanctioning or validation of prior acts. Likewise, the court noted that some sources list the words "authorize" and "ratify" as synonyms. Thus, according to the court, absent contrary evidence of the drafter's intent, the word "authorize," as used in Subsection 9-509(b), likely has a broad meaning encompassing both its forward-looking and retroactive meanings.

The court found that the Official Comments to the UCC support a broad interpretation of the word "authorize." For example, Comment 4 to UCC Section 9-322 states that an unauthorized filing "becomes authorized, and the financing statement becomes effective, upon the debtor's post-filing authorization or ratification of the filing." Accordingly, the court found that the commentators clearly intended that filings could be "authorized" after the fact. Therefore, because Subsection 9-509(b) states that execution of a security agreement authorizes a filing, the court held that a debtor's execution of a security agreement has the effect of retroactively validating a financing statement filed without the debtor's prior written authorization.

The court found additional support for its holding in the policies underlying the UCC's filing requirements. According to the court's analysis, the UCC's filing requirements are based on a policy of encouraging parties to put potential creditors on notice, as early as possible, that a debtor's assets may be encumbered. That goal was met in this case, according to the court, especially given that the pre-filing did not prejudice the debtor or any other party. Therefore, the court held that the parties' execution of the security agreements validated Capital's pre-filed financing statement and perfected Capital's lien. Consequently, the court dismissed the committee's claims against Capital.

Prior Authorization

Where secured transactions are very likely to close, there may be good reason for prospective secured parties to pre-file their financing statements. For example, pre-filing a financing statement can eliminate the necessity and cost of a post-closing lien search. In the event that a financing statement is inadvertently filed without prior written authorization from the debtor, the court's holding in Adoni should protect the validity of a secured party's lien, as long as the debtor ultimately ratifies the filing by executing a security agreement.

A caveat: The Adoni holding is the interpretation of a single bankruptcy court and it remains to be seen whether other courts will agree with its reasoning. Thus, the Adoni holding notwithstanding, it remains the best practice for secured parties to refrain from pre-filing a financing statement without obtaining prior written authorization from the debtor, or to obtain an explicit post-filing ratification of any UCC-1s already on file. After all, if a debtor does not ratify the filing by executing a security agreement and the intended financing transaction never closes, the pre-filing party could be liable for damages under UCC Section 9-625, especially if the debtor is unable to obtain alternative financing as a result of the unauthorized filing. If, for any reason, the transaction does not close, the pre-filing party should immediately file an amendment terminating its pre-filed financing statement.

Rudolph J. Di Massa Jr., a partner at Duane Morris, is a member of the business reorganization and financial restructuring. He concentrates his practice in the areas of commercial litigation and creditors' rightsChad E. Odhner is an associate in the Philadelphia of the firm, where he practices in the areas of commercial finance and restructuring.


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