Frequently Asked Questions

1. What is the UCC?

UCC Insurance, at least from the perspective of First American, is a product line of insurance products, which insure the attachment, perfection, and priority of a secured party's security interest in personal property.

2. Is UCC insurance comparable to land title insurance?

Sort of. UCC insurance is not title or ownership insurance because a title recordation system for most forms of personal property does not exist. However, a registry does exist for certain types of collateral such as motor vehicles, and other types of specialized collateral, such as rolling stock, railroad cars, where the Bureau of Surface Transportation of the Department of Transportation of the federal government maintains a registry. There is no comparable registry for who owns the computers in that warehouse, the lender's debtor or someone else. The UCC insurance assumes the debtor has rights in the subject collateral and insures the priority of the lender's lien in the collateral to the extent of the debtor's interest therein. In some limited circumstances involving equity interests and other special cases, the UCC insurance policy can insure ownership through endorsement to the policy.

3. If the UCC insurance does not insure ownership, what is the value of the insurance to a lender?

We view our UCC insurance products as consisting of three component parts. The first is the insurance component whereby First American, a Fortune 500 company, insures the priority of the lender's lien in the personal property collateral. If someone challenges the priority of the security interest, for example a creditors' committee through an adversary proceeding in a chapter proceeding involving the debtor, First American will defend and indemnify the insured against any loss to the extent of the diminution in collateral value resulting from the lien priority challenge. Given the scope of Revised Article 9 and the reduction in available collateral for the reorganization process, we expect lien priority challenges to increase in the years ahead.

The next component is what we call a "second set of eyes." We have a large group of highly trained UCC specialists who, through our underwriting process, assist our clients in evaluating their Article 9 compliance issues. For example, if we are asked to insure the priority of a security interest in a deposit account, now permissible collateral under Revised Article 9, we will review the related control agreement among the lender, the debtor and the depository, for sufficiency to perfect under Revised Article 9. If insufficient, we will suggest changes to lender's counsel that will bring the document into conformity with the requirements of Revised Article 9 for a deposit account control agreement and allow us to issue the requested policy. There are many other examples where we provide an experienced sounding board for our clients and their counsel during our underwriting process and respond to their technical Article 9 questions.

The third component of our products is outsourcing. Primarily for the lender that does not have a significant compliance staff, such as the community or regional bank where loan volume does not warrant extensive staff, we will for the premium, prepare the appropriate financing statements for filing under Former Article 9 and Revised Article 9, file the financing statements in the appropriate jurisdictions, and then track the scheduled lapse dates in our proprietary UCC tracking system. If we don't advise the lender of a pending lapse date in time to continue the filing and the financing statement lapses and priority is lost, any resulting loss is on us.

4. But does not the opinion of borrower's counsel on the status of the security interest satisfy the insurance component of your product?

In a word, "No." First of all, the opinion of borrower's counsel is usually directed only to perfection. Our insurance products cover priority. Further, usually the perfection opinion is little more that advice that the form of the financing statements meets the particular state's requirements as set forth in the CCH Secured Transactions Guide. Given the fact that lender's counsel prepares the financing statement, the opinion is being asked of the wrong lawyer and, getting over that issue, is generally useless.

Further, we insure on a nationwide basis and thereby avoid many of the multijurisdictional issues facing practitioners under Revised Article 9. For example, under Revised Article 9, the law of the jurisdiction of a registered entity (e.g., corporations, limited partnerships, limited liability companies) governs perfection, the effect of perfection and priority of a security interest. As a result, a California lawyer will now be asked to give a perfection opinion with respect to a Delaware corporation headquartered in California with all its assets in California under Delaware law rather than California law which would have been the case under former Article 9. Further, the policy can also be used to avoid the need to engage local counsel in situations such as where a Missouri corporate subsidiary is guaranteeing the obligations of its parent on a secured basis. Assuming for this discussion that the Missouri collateral is not the primary reliance collateral in the transaction, the UCC policy can replace the need to hire local Missouri counsel for the debtor/guarantor and perhaps also for the lender.

Finally, the UCC policy can provide added assurance to the lender in those lower dollar transactions where no legal opinion is required or could be obtained from counsel for the borrower. In these situations, the lender is effectively relying on its own counsel and the representations of the borrower in the loan agreement. By insuring the priority of the security interest, the UCC policy is effectively insuring the corporate organization of the registered organization borrower, and the borrower's authorization, execution and delivery of the lien-granting document to the extent of the grant of the security interest. It would be disingenuous to say that the policy matches a borrower's counsel legal opinion, for the UCC policy does not insure the enforceability of the lien granting document, such as a loan and security agreement, beyond the grant of the lien, nor does the UCC policy cover whether or not the borrower is a public utility holding company. However, the UCC policy does provide a level of assurance greatly in excess of the minimal comfort level provided by the representations and warranties of the borrower for the loan that does not warrant legal counsel involvement.

5. But doesn't lender's counsel backstop the limitations in a borrower's counsel opinion?

Yes, in those transactions that warrant the involvement of counsel for both the lender and the borrower. Again, many transactions are of insufficient loan value to warrant the involvement of counsel. In those transactions, the UCC insurance provides significant greater protection than reliance solely on the representations and warranties of the borrower.

However, in those transactions that do warrant counsel involvement, as we have discussed, the opinion of borrower's counsel, at least as to UCC perfection issues, is worthless and the legal cost of negotiating the opinion paragraphs usually exceeds any utility. However, the really useful opinion is, in fact, not in writing at all. It is the effective legal opinion given by lender's counsel where, at the closing, the lender looks at its lawyer and asks if everything is approved and is funding to occur. Lender's counsel says yes and the lender relies on this go ahead to fund. I consider this approval of the transaction counsel's acknowledgement that its lender client has the lien priority position that the lender expects. This go ahead is a priority legal opinion! And this "opinion" is the real legal exposure for lender's counsel. In a default that leads to the bankruptcy of the debtor, no one usually argues over the loan or security agreement provisions. The debate is over perfection and priority of the lender's security interest in the assets of the debtor. The loan agreement, over which everyone spends countless hours in negotiation, is primarily a fee generation opportunity, through the financial and other covenants, upon a default by the debtor. In fact, with a well-crafted loan agreement, the debtor is always in default. But again, in a bankruptcy, these well-crafted documents usually don't matter. What matters is perfection and priority.

Now, on what information is counsel for the lender relying in giving its priority legal opinion? Usually, the search report of a paralegal presenting a review of existing filings. The malpractice risk to the law firm rides or falls on this review. UCC insurance offloads all of this malpractice risk to the insurance company, for little premium cost and, more importantly, very little reduced legal fees to the lender's law firm.

6. Going back to an earlier question and answer, you mentioned that the UCC policy could insure "ownership" of equity. Please explain.

In the equity context, if the equity is a "security" for Article 9 purposes, and the insured lender becomes a "protected purchaser" under Article 8 of the Uniform Commercial Code, we will remove from the UCC policy the assumption that the debtor has rights in the equity collateral. This removal of the rights assumption effectively insurers ownership.

Not necessarily. Common stock in a corporation, yes. But membership interests in a limited liability company and partnership interests in general and limited partnerships, apart from certain exceptions, such as publicly traded partnerships, are not "securities" for Article 8 purposes nor "investment property" under Article 9 without some additional action.

A membership interests in a limited liability company and a partnership interest in a general or limited partnership is, initially, a general intangible under Article 9. Our UCC policy will insure the filing priority of a lender in such equity interests, but a subsequent lender who perfects its security interest in such equity interests by possession or control can trump this filing priority.

You are right to a point. If the issuer of the equity "opts into" Article 8, electing that its equity be governed by the provisions of Article 8, the act of opting in changes the equity from a general intangible to a security, opening up the possibility of double issuance of the equity. If a subsequent purchaser, including a secured party, is a "protected purchaser" under Article 8 and so perfects its security interest by control, the second secured party will take the equity at foreclosure free of any adverse interest including the filing priority of the first secured creditor..

You are right. We have come across a number of lender lawyers doing mezzanine finance or taking the equity of a borrower in pledge, who will require the issuer to type up a beautiful certificate "evidencing" the membership interest in a limited liability company, then take possession of the certificate on behalf of their lender client, and feel very secure and not file a financing statement. The result is that they only have an attached security interest in the equity. Their lender client is not perfected and will lose to a trustee in bankruptcy or to any perfected secured creditor. One cannot capture a general intangible in a piece of paper no matter how pretty the paper.

No lender should take a security interest in equity collateral that is not otherwise a security for Article 9 purposes. Lenders should always require issuers to "opt in" to Article 8, get "control" of the equity, and establish their position as a "protected purchaser" under Article 8.

We can assist in this process and through our Mezzanine or Pledged Equity Endorsement insure that all the steps have been followed by insuring the ownership of the equity in the pledgor and the priority security interest of the issuer in the pledged equity.

We think it is, and given our success in introducing the UCC policy with the Mezzanine or Pledged Equity Endorsement, the market seems to agree with us.

Yes, quite a few. In the area of mixed collateral, real and personal property securing the same indebtedness, the UCC policy, when coupled with a land title policy, offers a number of advantages. First of all, combining the two policies avoids any debate as to whether a particular piece of "personal" property is a fixture, such as a turbine in a power plant, an MRI machine in a hospital, or built-in appliances in a restaurant. The linkage of land title and the UCC policy insures the collateral whatever it is, and avoids the cost and debate over a legal opinion trying to decide the issue.

Further, in those jurisdictions where the UCC policy is classified as land title for regulatory purposes, allocating collateral value between real and personal property and tying the UCC policy with a land title policy, can result in a lower aggregate premium because of the usually lower premium cost per $1000 for the UCC policy over the premium for land title.

The UCC insurance is either land title insurance or property and casualty insurance for State regulatory purposes depending on a particular State's insurance statute. Because of regulatory constraints, we cannot tie a P&C product with a land title product.

13. Even if it saves the customer money?

Yes.

Let your imagination be your guide. We have insured the lien free status of collateral being sold in a sale free and clear of liens in a bankruptcy, effectively insuring the adequacy of the notice list. We have also been involved in a transaction where there was a question of whether collateral was an instrument or a payment intangible, and counsel were unwilling to opine as to status. The lender was concerned because in the particular transaction it was impossible for the lender to take possession of the paper. We provided an endorsement to the policy insuring against any loss resulting from the collateral being deemed instrument collateral. We have also insured lien priority in houseboats, rolling stock, vessels, whatever is Article 9 collateral. We also solved a deadlock where counsel for a borrower refused to provide a perfection opinion and the lender refused to go forward. Counsel for the lender brought us in and we provided a priority policy, and the lender waived the perfection opinion requirement of borrower's counsel.

15.What about intellectual property?

Contrary to some peoples' understanding, a security interest in patents and trademarks can be perfected under Article 9 as a general intangible. Without more, our UCC policy will insure the priority. The catch with patents and trademarks is that a bone fide purchaser of rights in a patent or trademark, if a collateral assignment or similar encumbering document has not been filed with the U.S. Patent and Trademark Office by the secured party, will take free of the UCC perfected security interest. We have an endorsement where we will insure the status of a search of the records of the PTO, but the only way a secured party can truly protect its security interest in patents and trademarks is to file in the UCC records and with the PTO. However, there are many transactions where the patent or trademark collateral is not reliance collateral and all the lender wants to do is defeat a trustee in bankruptcy. If that's the case, our UCC policy satisfies the needs of the lender with respect to patents and trademarks.

Copyrights are a different matter. Because of the language of the Copyright Act, courts have held, as distinguished from patents and copyrights, that federal law preempts state law. As such, a security interest in a filed copyright can only be perfected through an appropriate filing with the Copyright Office. This conclusion is true for filed copyrights. There is some debate over "copyrightable material," material that could be but is not the subject of a filed copyright. The better reasoned authority is that one can perfect a security interest in copyrightable material through the filing of a financing statement in the appropriate UCC records. If that is the law, our UCC policy will clearly cover copyrightable material as a general intangible. We also have an endorsement that will insure the status of a search of the Copyright Office.

16.The UCC insurance sounds like it meets the needs of many financial institutions. How long has the product been out and is First American the only insurance company offering the product?

First American officially introduced the UCC lender's policy at the Commercial Finance Association Conference in New Orleans in October 2000. Although we were alone in the market with the UCC policy for about a year and a half, all major land title companies have now either introduced a similar insurance product or are, to our understanding, in the process of introducing a similar product. We are happy to have the competition because it validates the concept originated by First American.

17.Are there differences among the competitive products and the related services offered?

Yes there are, and any potential customer should review these issues with the First American marketing representative or all the UCC Division of First American in Santa Ana, California at 800.700.1191. We believe we provide better coverage, a greater array of useful endorsements, the willingness to customize endorsements to fit particular circumstances, and the responsiveness of our UCC Specialists, many of whom have over 2 years of experience underwriting UCC policies, to customer needs.

18.You mentioned a lender's policy; do you have more than one type of policy?

Yes, the lender's policy insures the priority of a lender's security interest in the collateral of a debtor or debtors. We also have what we call a "buyer's policy," which insures the lien status, or lack of liens, in assets being acquired by a buyer from a seller. The policy can be used in asset acquisitions, mergers and similar transactions. We also have a policy that insures available points in non-deeded timeshare programs, and a policy that insures cooperative interests in cooperative real estate projects, but this policy is limited to New York because of the unique provisions regarding cooperatives in New York's Uniform Commercial Code.

19.Sounds like a great array of products and services.

It is.