August 28, 2019
THE REALITIES OF ACCESSION PRIORITY
Lenders often finance items that are installed in and/or affixed to their customers’ other leased or financed assets. When these items, known as “accessions,” are part of the transaction, they are usually “perfected” by the filing of a Uniform Commercial Code (UCC)-1 Financing Statement in the jurisdiction where the customer is incorporated. The questions that arise, increasingly, are: “Who has lien priority if the customer defaults?” and “How do we ensure that we will have lien priority on our collateral?”
The answers require an understanding of the UCC, engaging in proper due diligence and lien perfection practices, and the employment of the appropriate language in your transaction documents.
At the outset, the general proposition is that if a lender financing the accession (“Accession Lender”) has a properly perfected purchase-money security interest in the accession, the Accession Lender’s security interest will be afforded priority, regardless of whose security interest was perfected first. (UCC Section 9-324(a)). Notwithstanding, Accession Lenders should consider the following nuances and exceptions:
When the primary asset is a motor vehicle, an Accession Lender has no priority, even with a purchase-money security interest, where its addition is affixed to a third party’s titled vehicle, even if it timely and properly perfected its security interest. UCC Section 9-335(d) provides that a lender’s security interest in an accession is subordinate to a security interest in the whole, which would be perfected by compliance with that state’s certificate of title statute. So, even if the Accession Lender timely perfected its security interest, its security interest in the accession is subordinate to the holder of the lien noted on the title certificate of the vehicle. The policy behind this special “super priority” rule is that secured parties should be able to rely on a certificate of title without having to check the UCC records to determine whether accessions to the vehicle may be encumbered. This rule imposes a risk on financers of accessions that will be affixed to titled motor vehicles. Accession Lenders should proceed with caution and, where appropriate, seek acknowledgment from the motor vehicle lender.
Where an Accession Lender does not have a purchase-money security interest and the accession is not installed and/or affixed to a motor vehicle, the general rule is that the security interest of the Accession Lender has priority, notwithstanding that the accession is affixed to a larger piece of equipment subject to a security interest in favor of a third party, so long as: (1) the Accession Lender perfects its security interest before the accession attaches; and (2) the attachment does not cause the accession to become so incorporated into the larger equipment so as to render it collectively as one piece of equipment, e.g., a large set of integrated machinery where the removal of one piece would render the equipment useless. (UCC Section 9-335).
For example, a mail printing company obtains financing from a lender (the “Primary Lender”) for the purchase of a printing press, in which the Primary Lender has a perfected security interest. The printing company then acquires from the Accession Lender an add-on used to produce certain types of mailers and grants a security interest in the add-on to the Accession Lender. Provided that the Accession Lender has perfected its security interest in the add-on before it is installed and/or affixed into the printing press, the Accession Lender’s security interest in the add-on has priority.
If, however, the Accession Lender perfects its security interest after the add-on is installed and/or affixed to the printing press, its interest is subordinate to the Primary Lender but is protected against subsequent secured parties and/or purchasers of the printing press.
If a lessor is leasing an accession, the rights of lessors, lessees, and their respective creditors in those accessions are governed by Article 2A of the UCC. Generally, if a lessor or lessee’s interests in the goods are identified in the lease before those goods become accessions, those interests are superior to all interests in the whole. (UCC Section 2A-310(2)). Goods are deemed “identified” in a lease when the lease is made if the goods are in existence at that time. Identification otherwise occurs when the goods are shipped or designated by the lessor as being subject to the lease. (UCC Section 2A-217).
Moreover, if a lessor or lessee’s interests in the goods are identified in a lease at the time or after the goods became accessions, it is subordinate to the interests in the larger equipment that were existing at the time the lease was entered but takes precedent to all subsequently acquired interests in the whole. This is the case unless the existing lienholders in the whole have provided written consent to the lease or disclaimed an interest in the goods as part of the whole. (UCC Section 2A-310(3)).
Additional Exceptions to the Rules
The UCC provides further limited exceptions to these rules of priority. The first exception is that the interests of the lessor and the lessee in the leased accession are subordinate to the interests of buyers and lessees of the whole in the ordinary course of business after the leased goods became accessions. (UCC Section 2A-310(4)(a)).
The second exception is that the interests of the lessor and the lessee under the lease are subordinate to holders of pre-existing perfected security interests in the whole who make subsequent advances without knowledge of the lease. (UCC Section 2A-310(4)(b)). Therefore, if an Accession Lender with a lien on the accession provides additional financing secured by the accession before the Accession Lender learns of the existence of the lease, the lessor’s interests will be subordinate to those of the Accession Lender.
A third exception is where an existing lienholder, if willing to do so, provides written consent and/or disclaims its interest in the goods.
Things to Consider
Whether you are leasing or financing goods that may become installed in and/or affixed to another’s goods, the following preemptive measures may be taken to limit any potential subordination of your security interest in an accession:
- when financing a titled vehicle, a Primary Lender should insist that the financing include anything affixed to the vehicle;
- a lessor and/or Accession Lender should provide notification, e., a UCC notice, in accordance with the requirements for a properly perfected purchase-money security interest, to any secured creditors with liens on the equipment to which the accessions will be installed and/or affixed;
- a Primary Lender with a perfected security interest in equipment should always include boilerplate language in the security agreement to capture a security interest in accessions to the equipment;
- an Accession Lender should perform a UCC search to confirm whether a Primary Lender has any liens in the accessions to the equipment in order to avoid potential litigation and, where necessary, enter into an inter-creditor agreement to establish whose lien in the accessions will be subordinate;
- a lessor in a true lease should still file a UCC-1 Financing Statement out of an abundance of caution in the event that the lease is deemed to be a “finance lease” under Article 2A of the UCC;
- a lessor should include language in the lease prohibiting the attachment of its subject leased goods to other goods without the lessor’s prior written consent;
- a lessor should, where possible, require the lessee to mark the goods as leased from the lessor;
- obtain written acknowledgments from the customer and any lender that the accession has not and shall not be so integrated as to make it part of the underlying equipment; and
- the subject equipment of a sale leaseback should be evaluated to confirm that the equipment has not already been affixed to another unit.
With a properly negotiated and carefully drafted agreement, the exercise of due diligence, and the timely perfection of your security interest, you can ensure that your accession will receive the priority that it warrants.