How to Perfect a Security Interest?
A secured party should perfect their security interest, after attachment, in order to fully ensure its legal rights against a third party claiming that they have an interest in the same collateral. By perfecting a security interest, a secured party gains priority over subsequent creditors claiming the same collateral.
A secured party can perfect a security interest by:
- Filing a financing statement;
- Possessing the collateral;
- Controlling the collateral; or
- Automatic perfection
Perfecting a Security Interest with a Financing Statement
The most common way to perfect a security interest is through filing a financing statement. A financing statement is filed with the Secretary of State and it puts other creditors on notice of the secured party’s security interest in the collateral. The filed financing statement is effective for a period of five years after the date of filing. U.C.C. § 9-515(a). In order to abide by the UCC’s requirements, the financing statement must (1) name the debtor, (2) name the secured party, and (3) indicate the collateral.
The name of the debtor on the financing statement must be specific and accurate because financing statements are filed under the debtor’s name. Therefore, if the name on the financing statement is incorrect, the financing statement will not provide notice to other creditors and the security interest will not be perfected.
Furthermore, a financing statement’s indication of the collateral requirement is similar to the requirement of describing the collateral in the security agreement. A financing statement sufficiently indicates the collateral that it covers if the financing statement provides either (1) a description of the collateral that reasonably identifies what is described or (2) an indication that the financing statement covers all assets or personal property. U.C.C. § 9-504. The difference between the description of the collateral in the security agreement and the financing statement is that on a financing statement it is acceptable to use a super generic description of the collateral. Therefore, statements like “all the debtor’s personal property” or “all of the debtor’s assets” are acceptable in a financing statement.
To file a financing statement a secured party may use Form UCC-1.
Perfecting a Security Interest through Possession
A secured party may perfect a security interest in negotiable documents, goods, instruments, money, or tangible chattel paper by taking possession of the collateral. U.C.C. § 9-313. If a secured party has perfection through possession, it can either take personal possession or it can designate an agent to take possession. If an agent secures possession, the agent must authenticate a record acknowledging that it holds possession of the collateral on behalf of the secured party. U.C.C. § 9-313(c).
A secured party cannot obtain perfection through possession for all collateral. For example, intangible collateral such as accounts receivables and deposit accounts cannot be perfected through possession.
Perfecting a Security Interest through Control
A secured party may perfect a security interest through control only in certain collateral. Only the following collateral can be perfected through control: investment property, deposit accounts, letter of credit rights, and electronic chattel paper. Perfection by control remains perfected only while the secured party retains control.
Automatically Perfecting the Security Interest
There are some security interest that become automatically perfected upon attachment of the security interest to the collateral. U.C.C. § 9-309 sets out a list of thirteen security interest that are perfected when they attach. However, the most common type of security interest that is perfected upon attachment is known as a purchase money security interest (“PMSI”) in consumer goods.
A PMSI involves either (1) a transaction where the secured party provides the financing to the debtor to purchase the collateral securing the loan or (2) a transaction where the debtor buys an item on credit from a seller. If the debtor is buying consumer goods, then the secured party automatically perfects its purchase money security interest. U.C.C. § 9-108(23) defines consumer goods as goods that are used or bought for use primarily for personal, family, or household purposes.
Perfection occurs automatically only if the PMSI is in consumer goods, therefore a secured party must make sure that the debtor’s goods classify as consumer goods under the definition provided in the U.C.C. § 9-108(23).