Be wary of unauthorized UCC filings!

Recently, the New York District Court case Roswell Capital Partners LLC v. Alternative Construction Technologies ruling effectively extinguishes one creditor’s security interest due to an arguably ineffective termination by an unauthorized party.

Although the ruling in this case is not the norm, instances of unauthorized UCC filings are prevalent on the public record and thus always present a certain level of risk to a secured transaction. During due diligence, it is the duty of a searcher to analyze and investigate the records, and identify effective versus ineffective filings.

As an introduction to and illustration of the issue, let's start with a couple examples:

• Scenario #1: A UCC search is conducted, and the results indicate the following: a) A UCC-1 was filed by Bank ABC on June 1, 2005. b) On December 1, 2008, a termination statement was filed listing Bank ABC as authorizing party. c) On January 8, 2010, Bank ABC filed a timely continuation statement. Given this unusual sequence of events, the searcher would be faced with a key question to answer: is the continuation statement effective, or did the earlier filing of the termination statement effectively terminate Bank ABC’s interests?
• Scenario #2: Similar scenario, but note the key difference marked here in bold print. A UCC search is conducted, and the results indicate the following: a) A UCC-1 was filed by Bank ABC on June 1, 2005. b) On December 1, 2008, a termination statement was filed by Bank XYZ as authorizing party. c) On January 8, 2010, a timely continuation statement was filed by Bank ABC. Again, the searcher is faced with the question: is the continuation statement effective, or did the earlier filing of the termination statement effectively terminate Bank ABC’s interests?

In the first example, it appears that Bank ABC had the authority (as secured party of record) to file a termination, but may have done so by mistake, and later tried to file a continuation. If that was the case, the termination was effective, and Bank ABC no longer has a perfected security interest, despite the later filing of a continuation statement. In the second example, it appears that Bank XYZ was not the secured party of record, and most likely Bank XYX filed the termination by mistake. In this scenario, since Bank XYZ did not have the authority to file the termination, the termination was ineffective, and the continuation statement filed by Bank ABC is effective.

Although the facts are slightly different, the starting point for analyzing both examples is the same: Did the party filing the UCC record have the authority to file it? However, although we know the key question to ask, the answer cannot be determined solely by reviewing the UCC search results. A searcher must take additional steps to ascertain the validity of each filed record.

For instance, using the facts provided in the second example, it is possible that Bank XYZ may have had the authority to file on behalf of Bank ABC (Section 9-502, et al, allows a “representative of the secured party” to act on behalf of another secured party if authority exists). If Bank XYZ had such authority, then the termination filed by Bank XYZ was effective to terminate Bank ABC’s interest.

ABCs can make going out of business smoother and quieter

This is a fantastic and extremely relevant article by Cyndia Zwahlen from the Los Angeles Times.  The last quote by former business owner Ken Bowers truly sums up the problem for most if not all business owners:

""Probably the worst thing on a small-business owner is giving up. It's not in our nature," Bowers said. "My advice: Separate your emotions from the reality … and accept that you are not going to make it."

ABCs can make going out of business smoother and quieter

Lesser-known option to bankruptcy avoids courts, which can save money and time. But it is appropriate for a limited number of situations and owners are still responsible for personal debt guarantees.

By Cyndia Zwahlen

January 3, 2011

After three years of trying to make a success of his small Cerritos company that manufactured corrugated boxes, Ken Bowers was in deep financial trouble.  He and his wife, Jeannie, had been pouring their own money into the company in a last-ditch bid to save it, but the firm was too far gone. Instead of a business bankruptcy filing, however, Bowers' banker proposed a different way out.

"He suggested we file an ABC," said Bowers, referring to a process technically known as a general assignment for the benefit of creditors. ABCs have been around for more than a century and supported by California law since the 1930s, said Michael Joncich, who oversees the general assignment unit of the Credit Management Assn. in Burbank.

But few business owners were familiar with them.

"I'd never heard of it but learned it's a way to liquidate the business and it really doesn't put you so much at odds with your creditors," said Bowers, whose company once had 20 employees.

An ABC, under the right conditions, can go more smoothly than a Chapter 7 bankruptcy filing.

"Assignments are faster, more efficient and generally return better to creditors than bankruptcy cases," said Geoff Berman, vice president in the Los Angeles office of Development Specialists Inc. and author of a manual on ABCs published by the American Bankruptcy Institute, of which he is president-elect.

Both processes end with the sale of a company's assets. But an assignment in California is not court supervised, and that can save time and costs. An ABC is also usually a more private process.

Instead of a U.S. Bankruptcy Court appointing a trustee to liquidate the company, the business owner hires an assignee — often an insolvency lawyer or specialist with experience in ABCs — to sell the company's assets and distribute the proceeds to creditors. The assignee has a fiduciary duty to try to get the highest price for the assets.

"We signed the assignment and right away [the assignee] took over everything," said Gurmeet Singh, who used an ABC to close his formerly 40-person business, Precision Gear of Corona, two years ago. "He had a locksmith right there and he got the locks switched and we were out of business. Then he got some people in to take inventory of things."

But an ABC is appropriate for only a limited number of situations.  They are not a good fit for a company that isn't incorporated. Without the legal shield that incorporation provides, owners can be held responsible for company debts.  If a business owner has made a personal guarantee to cover a debt, an ABC won't wipe that out either. That was an unfortunate hitch for Bowers, who took out a Small Business Assn. loan to buy factory equipment. He used his house to guarantee the loan.

"I don't want to mislead people, because one thing is, to the extent they have made personal guarantees, whether it be for a product or on their loans, they are not released from those" in a general assignment or a bankruptcy filing, said attorney Robert L. Cohen, who runs Alternative Bankruptcy Concepts Inc. in Buena Park.

Another restriction: If the business is upside down with a secured creditor — meaning that the debt owed is higher than the pledged collateral is worth — this secured creditor will need to agree to the ABC before it can go forward.

Finally, the biggest disadvantage to an ABC is that it does not completely close the door on creditors trying to collect what's owed them. A bankruptcy is more final.

Here is how the money flows in an ABC: After the sale, the assignee is paid from the proceeds. The amount of that pay can vary greatly, from about $25,000 to $100,000 when dealing with a small business. Some assignees get a flat fee, some collect a percentage of the proceeds and others get a combination of the two. Singh, for example, said his company's assets sold for $400,000. Out of that, the assignee was paid about $50,000.

After the assignee is paid, that person distributes the rest of the proceeds from the sale to creditors.

The process works best for business owners if the ABC is done before their firms fall too deep in debt. That's especially true if the owners are pouring their own money into the business in an attempt to save it.

That's what happened to Bowers and Singh. Even though their ABCs helped them pay off their companies' debts, both of them eventually filed personal bankruptcies.

Bowers said in retrospect that he should have sought debt relief much sooner.

"Probably the worst thing on a small-business owner is giving up. It's not in our nature," Bowers said. "My advice: Separate your emotions from the reality … and accept that you are not going to make it."

The Business, Commercial & Bankruptcy Law Section of the Barristers Club presents Alternative Strategies in Assisting Distressed Companies

I would like to invite everyone to the presentation I am giving at The Business, Commercial & Bankruptcy Law Section of the Barristers Club on January 13th.  The title of the presentation is: Alternative Strategies in Assisting Distressed Companies.

This presentation is not a sales pitch for Acrius Capital, but rather an informative presentation to bankruptcy attorneys since they all deal with distressed companies.  I hope you can come, and please forward this on to anyone that might want to attend, especially attorneys, bankers, and accountants.

Here is their web site: http://www.sfbar.org/calendar/eventdetail.aspx?id=B111223/B111223.

It would be great to see you there!

Upcoming events where you can find Acrius Capital

12/2/10: Western M&A Conference

San Francisco Marriott; 55 Fourth Street

12/3/10: Kustov and Associates, Inc. Holiday Party

Performance Art Institute; 575 Sutter Street

12/6/10: Financial Women's Association of San Francisco Annual Meeting and Holiday Party

420 Montgomery Street, Wells Fargo Historic Building Penthouse, San Francisco

12/7/10: First Bank Holiday Party

460 Montgomery Street

12/8/10: Dreamforce '10 Global Gathering

Moscone Center, San Francisco

12/9/10: ProNet Holiday Party

Hyatt – Embarcadero Center

12/9/10: Turnaround Management Association (TMA) of Northern California Holiday Reception

Rouge & Blanc Wine Bar, 334 Grant Avenue

12/16/10: Association for Corporate Growth (ACG) Holiday Mixer      

Pier 3, Embarcadero

1/13/11

John Seeley will be the Speaker at The Business, Commercial & Bankruptcy Law Section of the Barristers Club.  His presentation is called, ‘Alternative Strategies in Assisting Distressed Companies.’

BASF Headquarters at 301 Battery Street, Third Floor.

Important Factors that Asset-Based Lenders Consider for Providing Financing

One of the first questions we are asked by a prospective borrower is, “How important is my credit?”  With rare exceptions, the answer from us is, “It isn’t.”  People are used to buying car or houses or applying for a credit card or a bank loan where the most important question is, “What is your credit score?”  Now that banks and other ‘traditional’ lending institutions are hoarding their TARP money and turning down loans, the credit market is a different and oftentimes unfamiliar territory for borrowers.  During the economic boom of 2004 to mid-2008, business owners were courted by many banks and offered extremely low rates and had to offer very little collateral other than their personal guarantee, but now they are seeing their credit lines slashed and many are being asked to repay the bank and leave.  Business owners are turning to alternative financing options, including asset-based lending, and they are learning that the rules are different.

Here are the factors that lenders consider when providing financing in the order of importance:

1.      Value of the collateral:

a.       Accounts Receivable: Credit strength of the customers who owe the money

b.      Inventory: liquidation value (greatly depressed in the current market due to a glut of unsold goods)

c.       Equipment: liquidation value (greatly depressed in the current market due to a high amount of repossessed equipment from failed companies)

2.      Repayment

a.       Can the borrower afford the interest expense?

b.      Are there any secondary sources of repayment if the company is unable to repay the loan? Example: sale of owner’s assets.

3.      Strong financial potential for the borrower

a.       The future is more important than the past. The borrower may have been losing money for the last 2 years, and if they have, then what is the turnaround plan for improving profitability to achieve break-even?

b.      How will the money borrowed improve the financial stability and performance of the borrower?

4.      Ownership and management team

a.       Management team’s experience

                                                              i.      If there is a turnaround required, does the management team have turnaround experience?

                                                            ii.      Do they have a credible plan for moving forward and are they implementing it?

b.      Strong Personal Financial Statement for owner

Believe it or not, financing is still out there, but it may be different than what you are used to.

Get business financing when you can, not just when you need it

Today I received a call that is becoming an increasingly common occurrence.  A company that turned down financing six months ago because they felt that they didn't need it yet, called and said they need money by the end of the week or they would probably have to shut the doors.  This is NOT an enticing opportunity for any lender, nor is it a realistic expectation for any borrower.  The company owes a bank and various vendors, and is unable to cover payroll because their customers are taking too long to pay them.   The company had strong sales growth and money was flowing in a few months ago, but Accounts Receivable collections went from 30 days to 60 days, and at $1 million of sales per month, this created a $1 million cash shortfall very quickly, even though sales are still solid.  Their decision to forego financing six months ago when they did not feel any urgency has effectively put the future of their company in jeopardy.  
It is possible to set up a credit facility without a monthly minimum, so the company will not incur fees until they actually borrow the money.  With a funding facility preapproved, the company can receive funds within 24 hours from making the request, even if the request is not until six months after initial approval.  
I hope that business owners will learn quickly that in this tight credit market, it is better to have financing in place when they do not have the immediate need, even if it is not being used, so they have money available to them at a moment’s notice when it is needed.