Loans and Liens and. . .What Can Go Wrong Here? Protecting a Lender's Collateral Position Under the UCC - Once Again the Devil is in the Details

By: John Easterbrook

The lender gets loan documents signed by the borrower and gets collateral to secure the debt – that is, a lien on the borrower’s property. It sounds easy and familiar. So what can go wrong here? The progression of cases interpreting the Uniform Commercial Code (UCC) provides insight into the mistakes, large and small, that can create unexpected exposure for lenders and surprise defenses for borrowers. Earlier this year two new cases shed additional light on this question. This article takes up the first of these.

Situation – A Lien on an LLC

The case involved an LLC membership interest offered as collateral for a commercial loan. 11 East 36 th, LLC (“36 LLC”) was the sole member of Morgan Lofts, LLC (“Lofts LLC”), which owned numerous units in a building. Both entities along with a third entity (the Borrower in this situation) were controlled by common family interests. As security for a loan to Borrower, the controlling family agreed to have 36 LLC pledge its sole membership interest in Lofts LLC.

When the transaction was documented, the pledge agreement granted a lien in favor of the lender in the Lofts LLC membership interest held by 36 LLC. The UCC-1, however, described the collateral as specific units in the building that were owned by Lofts LLC.

Bankruptcies were subsequently filed by 36 LLC and Lofts LLC and the lender’s security interest was challenged. The court held that the lender was unsecured as its UCC collateral description incorrectly described the collateral as the real estate owned by Lofts LLC and not the membership interest of 36 LLC in Lofts LLC. Although the lender had its security interest correctly described in the loan papers, it did not really matter because the UCC-1 had it all wrong. The court explained that 36 LLC had no interest at all in the real estate units owned by Lofts LLC; rather, its lien was on the membership interest and it never perfected that security interest. Accordingly, the lender was a mere unsecured creditor in the bankruptcy. In re 11 East 36 th, LLC, 2016 WL 1117588 (S.D.N.Y. March 21, 2016). The takeaway? A security interest in an LLC membership interest is very different than a security interest in the assets actually held by that LLC. The lesson is clear: make sure you accurately describe the collateral in the UCC-1 to properly perfect your interest in that collateral.

The information appearing in this blog does not constitute legal advice or opinion. Such advice and opinions are provided by the firm only upon engagement with respect to specific factual situations. Specific questions relating to this article should be addressed directly to Strategy Law, LLP.

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