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If your business participates in interstate commerce such as moving goods or money, establishing contracts of leasing equipment, you are required to comply with the Uniform Commercial Code. These and other business transactions that are regulated by the federal government require compliance with a consistent set of rules. Basically, UCC rules govern how commercial transactions are handled throughout the United States.
Most states have adopted UCC rules to regulate financial business transactions. The code has nine articles that address different aspects of loans and the banking system. Each helps to make it easier for lenders to make loans when necessary.
What is a UCC Filing?
Rules for UCC cover all types of commercial transactions for sales, leases and private financial arrangements. A UCC filing on your business is usually made to create a lien against property used as collateral. Typically, a UCC filing is required in order to secure private financing.
Protecting Transactions Across State Lines
Generally, commercial transactions occur across state lines. For example, products might be manufactured in Minnesota, distributed in Tennessee and sold to a customer in California. Money from the sale, whether through a bank account or credit card, often occur between the customer in California and the distributor in Tennessee.
Each state may have different laws about on commercial transactions that leave little or no protection for each party that is involved. UCC achieves the goal of creating uniformity on how state law – from each state – handles the transaction.
Why a UCC Filing is Important
A UCC filing is important for any business that has to borrow money from an out-of-state lender. You must also consider the importance of a UCC filing if you have to negotiate a lien.
Basically, a UCC filing on your business allows the out-of-state lender to have consistency for recording the security of your loan. Banks and SBA-approved lenders file a UCC-1 form with the state in which the loan agreement is executed. Typically, these loans require collateral of movable assets and the lender needs a way to secure with a public record of the transaction. Without a UCC, a lender risks having difficulties laying claims on the collateral if you were to default.
Concerning liens, a UCC filing works best for a business that issues credit for goods or services. For instance, your business might use credit to purchase office equipment. Article 9 of the UCC allows a business to secure payment from you for the purchase. If you fail to repay the debt according to the terms of an agreement, the lender can use the collateral as a form of repayment. They have the right to foreclose, seize or even sell the property.
What a Lien Does to Your Business
Now that you know why a UCC filing on your business may occur, it is important to understand how it can affect your business. Under state UCC provisions when tangible business assets are used as collateral, a UCC filing creates a lien. Once established, you cannot dispose of the property before the debt to the lender is paid.
Items that may fall under a UCC filing include:
• Office equipment
• Financed goods – farm equipment, heat pumps
• Commercial instruments such as drafts or promissory notes
• Letters of credit
• Investment securities
Other types of liens may include a mortgage on a building. A business vehicle may have a lien. Paying off the debt is the only way to remove the lien. You will not be able to get the deed on an office building or title to the company vehicle until the lien is paid in full. Your business is, however, allowed to use the building or vehicle while you are making payments.
Perfecting the Security Interest Under a UCC Lien
Additionally, UCC liens must be perfected to be recognized as valid against other creditors or lien holders that may have an interest in your business. Perfecting the security interest refers to statutory requirements that complete a lien. Perfection occurs when a lien holder files the UCC-1 form with the Secretary of State where your business is located.
Typically, the filing statement details the lien, the lien holder's identity and your identity. This statement becomes public record where potential lenders can verify whether a conflict of security exists.
If there is an existing lien on a piece of equipment, you will need to pay it off before another transaction can use the same collateral. Otherwise, the transaction becomes invalid and the lender will not issue credit or approve your loan.
The systems in place regarding UCC filings enable potential creditors to view public records before approving a transaction. It is best to be upfront about the situation and use some other form of collateral before attempting to complete a commercial transaction.
There is one exception to this rule. A blanket lien – where the creditor has rights to all of your business assets – could release some assets with a written statement from the creditor. Generally, a release is granted in this situation when you are replacing the collateral with an equally valuable asset.
Renewal and Termination of the UCC Filing
UCC rules provide an effective duration of UCC filings for five years. Creditors must renew the filing if the loan is not satisfied within that period. Failing to renew the UCC filing in a timely manner will result in a lapse and the lien is no longer perfected. Technically, the creditor could not challenge the lien in court.
Once you have satisfied the debt associated with a UCC filing, the creditor must file a UCC release form. Essentially, this serves as a termination statement regarding the lien. Any other creditor searching public records will see that there is no longer a lien on your business assets.
The Bottom Line for Your Business
Funding has been tight for many small businesses because of the financial crisis. Access to credit nearly came to a complete halt for business owners who needed to survive the meltdown. A few years after the recovery began, there is still a level of risk aversion that can make it harder for your business.
Traditional financial institutions commonly reviewed collateral and cash flow statements when deciding whether to lend money. Alternative funding sources with more lenient requirements have become attractive to business owners. Even though these alternative lenders are more willing than banks to make business loans, they still want security in being repaid.
Therefore, they will use a UCC filing as a secured agreement for repayment. Accessing funds through these sources can offer many benefits to your business. Nevertheless, you must understand what the filing does for your business. If you decide to use accounts receivable as a secured asset, the UCC filing usually places a lien on the accounts.
While this type of lien is not reported to a credit reporting agency, it does serve as a safeguard for the lender. Other potential lenders will also know that your customer invoices are not available as collateral. Your business credit rating is affected, however, if the loan is not repaid according to the terms.
Keep in mind that UCC laws may vary from state to state. In some cases, the fine print on a credit application serves as your UCC filing notice of the creditor's authority. Consulting with an attorney regarding UCC filings may help you make the best decision for your business.