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Purchase Money Security Interests – Value Limited

By Sherin and Lodgen on June 16, 2014

During a recent discussion, the topic of purchase money security interests arose and it seemed like a good topic for a quick review.  In Massachusetts, the concept of the purchase money security interest is codified at Article 9 to the UCC, under the heading, “Secured Transactions.”  Let’s briefly look at who is entitled to this type of security interest and, if you have one, what benefit does it provide?

First, a broad brush introduction to the Uniform Commercial Code.  Purchase money security interests arise under that body of law known as the Uniform Commercial Code, commonly referred to as the “UCC”.  The UCC was first published in 1952 and, with some variations among the various States, has been enacted by the 50 States, the District of Columbia, and Puerto Rico.  The UCC governs the sale of both tangible and intangible goods and serves the purpose of harmonizing what was a mismatch among the various States in the treatment of this type of property.  As commerce across the United States has become less local, the UCC has only become a more important body of law, enabling equal treatment with respect to this type of property and certain aspects thereof in varying jurisdictions.  For the purposes of this brief writing, each reference to a good shall refer to both tangible and intangible goods.  Additionally, this discussion addresses UCC treatment in a commercial, versus a consumer, context.  Finally, we will not explore how the UCC treats certain types of goods such as chattel paper, investment property, livestock, and deposit accounts.

When speaking about security interests in goods, there are three (3) concepts of primary importance:  attachment, perfection, and priority.  Attachment refers to the event giving rise to the security interest.  In the context of a purchase money security interest, attachment occurs upon sale or delivery of possession of the subject goods.  In most other instances, the security interest will attach upon execution of a security agreement, i.e., a contract between the debtor and the secured party that evidences the agreement between them relative to the goods to be secured.

Perfection refers to the action of the secured party in the context of a given secured transaction pursuant to which its security interest will take priority over other lien holders of the debtor.  With respect to a purchase money security interest, the secured party or vendor has a period of twenty (20) days following the sale (or delivery) of the subject goods during which its security interest is perfected; however, by the twenty-first (21st) day following the date of sale, the secured party must file a financing statement with the Office of the Secretary of State of the jurisdiction in which the debtor entity was formed in order to maintain its lien priority; if this step is not taken, the purchase money security interest will become an unsecured obligation of the debtor vis-à-vis other lien holders of the debtor.  In non-purchase money contexts, the secured party must file a financing statement in the jurisdiction in which the debtor entity has been formed contemporaneous with the execution of the subject security agreement.  In most instances in the non-purchase money context, the first secured party to file its financing statement of record as to a given debtor takes priority.

As can be inferred, priority in the secured transaction environment speaks to the lien position of each secured party in relationship with a given debtor, with a first lien position of critical importance to the secured party, as the secured party in a first lien position is in the best position to recoup on the value given in consideration of the security interest.  A secured party in an inferior lien position will only recoup to the extent there is any value remaining after the obligation to the first lien holder has been fully satisfied and unsecured creditors are even less assured of receiving any value in consideration of goods sold.

A purchase money security interest can attach in favor of (a) the vendor selling the subject goods, to the extent full value was not received from the purchaser (debtor) at the time of sale, or (b) a lender, to the extent proceeds are loaned to facilitate the purchase of the subject goods, each of whom shall enjoy the benefit of the purchase money security interest for a period of twenty (20) days.  Following the lapse of the twenty (20)-day period, the security interest will retain its purchase money quality vis-à-vis the vendor from whom the goods were purchased; however, priority will be based upon the order of attachment relative to the other unsecured creditors of the debtor.  Unless a financing statement is filed on or before the lapse of the twenty (20)-day period, the purchase money lien will not maintain priority over then-existing or future lien holders who perfect through the filing of a financing statement.

What benefit does a purchase money security interest confer upon a secured party?  A purchase money security interest is beneficial because it will always retain its preferential status until the purchase money obligation has been fully satisfied; however, the security interest will lose its priority over other secured parties, if the holder of the purchase money security interest does not file a financing statement in the jurisdiction of domicile of the debtor entity within twenty (20) days after the purchase money security interest attaches.  Practically speaking, once the safe harbor afforded by the twenty (20) day filing period has lapsed without perfection of the purchase money lien, the purchase money vendor can anticipate very little benefit from its purchase money relationship with the debtor.