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
If you have any questions on this topic or would like a free consultation,
please call Melissa Martorella, Esq.