More often now than in the past, lenders are accepting equity interests, partnership interests in partnerships, and limited liability company (LLC) membership interests as collateral for loans. However, a lender that takes a security interest in this variation of collateral must be cognizant of the unique methods necessary to perfect those security interests. If a lender is not careful to utilize the proper method of perfecting a security interest, it is possible that a secondary lender may gain priority over the senior position lender. This may allow an opportunity for the subsequent lender to take priority during the foreclosure process.
Whether the equity interests may be considered “securities” under Article 8 of the Uniform Commercial Code (UCC), or “general intangibles” under Article 9 of the UCC will determine which perfection method should be used to secure the position on the loan. If the documents governing a partnership or LLC do not address the applicability of these Articles, equity interests will be classified as “general intangibles” under Article 9, regardless of whether those interests have been certified.
To perfect a security interest in a filing statement, a lender must complete and file a financing statement. When there is more than one financing statement in competition, the security interests will be assigned to the financing statement in the chronological order that they are filed.
If the documents governing a partnership or LLC “opt in” to Article 8, then the method of perfection will be entirely different. Under Article 8, the equity interest is considered a “security” under Article 8 versus an “investment property” under Article 9. As such, according to Article 9 the lender may perfect the interest in one of three ways:
1. By properly filing a financing statement
2. By showing possession
3. By control, likely through providing documentation demonstrating an agreement for control of particular securities
When the interest is considered an “investment property,” perfection of the interest gains priority with each item on the above list. A lender demonstrating control of the asset will have a stake that supersedes a lender who can demonstrate possession; a lender that can demonstrate possession will supersede a lender that has properly filed a financing statement. Also, showing either control or possession will give a lender priority over another lender that properly filed a financing statement, even if that financing statement was filed before the first lender demonstrating possession or control.
As such, a lender taking a security interest must be careful to follow the proper procedure to ensure they perfect their interest in the security. This is imperative in protecting their asset against encroachment from competing interests.
