Volume 6, Issue 1 (Summer 2010)
UCC Revision Committee Wrestles With Individual Debtor Name Problem
Prepared By
Barkley Clark & Barbara Clark
Next summer, the Joint Review Committee on UCC Article 9 will seek final approval for a significant package of amendments to the statute. The state legislatures will begin to consider this package in late 2010 and early 2011. Most of the proposed amendments are important, but not controversial. The one area that has generated substantial controversy, and taken a huge chunk of the Committee's time, is the problem of how to create a clearer standard for designating the name of an individual debtor on financing statements. The Committee is currently considering three alternative approaches to this problem.
The Problem in a Nutshell. When a major revision of Article 9 was first considered in the early 1990s, one of the first issues to be tackled was how to simplify the filing/searching system. The solution for corporate debtors was to require a single filing in the state of the debtor's "location," which was the state in which the debtor was incorporated. The single financing statement was required to designate the name of the corporate debtor as it appears in the articles of incorporation-what some wags have called a "birth certificate" standard. This rule applies whether the collateral is tangible or intangible-a huge improvement over the multiple filings often required by prior law. The rule applies to any formal business entity, including LLCs. This rule has been the law in every state since 2001, and it appears to have worked well.
Unfortunately, in the drafting of Revised Article 9, precious little attention was given to filing financing statements against individual debtors, including sole proprietorships. There is little guidance provided by the text or Official Comments. In 9-503, the drafters simply refer to the debtor's "individual name." Section 9-521 clarifies the standard only a little by referring to "the debtor's exact full legal name" in the model financing statement form. And 9-506 refers to the debtor's "correct" name. So we have three different standards for individual debtors, none of which is particularly helpful, given a world filled with nicknames and middle initials. Significantly, nobody is really sure what a debtor's legal name is. Some argue that, under common law principles, a person's "legal" name is the name the person is commonly known by. Others argue that a person could have multiple legal names (e.g., Ringo Starr and Richard Starkey). There is no doubt that individual filings are huge; some materials submitted to the Joint Review Committee indicate that 50 percent of total UCC filings may be in individual names.
Nonuniform Amendments to Revised Article 9. Frustrated by the lack of a clear standard for determining the correct name of an individual debtor on a financing statement, four states-Texas, Tennessee, Nebraska and Virginia-have adopted non-uniform amendments in the last few years. The Texas legislature took the lead in 2007 by amending UCC 9-503 to make the debtor's driver's license the key document to use for the debtor's name in a financing statement when the debtor is an individual or sole proprietorship.
The Texas statute moors the secured creditor in a "safe harbor" if it uses the name on the debtor's driver's license. The security interest is perfected and thus can't be avoided by a trustee in bankruptcy. However, although the Texas amendment clarifies the standard, it still contains problems. It doesn't adequately tell secured creditors what to do if the debtor's driver's license expires, or is changed to reflect a new name such as a married name. Moreover, while the driver's license name is sufficient to perfect the security interest against a trustee in bankruptcy, it is not the only allowable name. The absence of "only if" language in the Texas statute could allow a prior filer under a different "correct" name to gain priority over a later lender using the driver's license name. Finally, the Texas amendment doesn't contain any transition rules. In short, the Texas amendment is an improvement, but still leaves some uncertainty. For a detailed critique of the Texas amendment, see Clark & Clark, The Law of Secured Transactions Under the UCC, ¶ 2.09[1][d][iv].
The Three Alternative Approaches Currently Under Consideration. The Joint Review Committee on Article 9 has been studying this issue for 18 months. It has come up with three alternative approaches to the individual debtor name problem. It will make a final decision soon. Let's take a look:
The do-nothing approach. The first approach is to leave the UCC as it is, on the theory that no huge problems have surfaced. The case law described below has generally come to the right conclusion that nicknames are a no-no and that the debtor's "exact full legal name" requires a full first name, a middle initial or full middle name, and a full last name. The do-nothing approach recognizes that there still may be variations of an "exact full legal name," but that proposed lenders can search multiple variations as part of their due diligence.
The safe-harbor approach. Under the second approach, Article 9 would be amended along the lines of the Texas non-uniform amendment. Creditors using the name appearing on the debtor's driver's license would be perfected against the challenge of a trustee in bankruptcy even though a court might find that other variations of the debtor's name qualify as the "exact full legal name." In other words, use of the driver's license standard is sufficient, but not necessary.
The "only if" approach. In recent months, the banking industry has spoken forcefully in favor of a third approach: the creditor's security interest is perfected "only if" the financing statement reflects the debtor's name as it appears on his/her driver's license. This is the approach that current Article 9 uses for corporate debtors. The bankers argue that this approach simplifies both filing and searching, and yields the most certainty. In particular, they point out that the "safe harbor" approach solves a secured creditor's perfection problem, but not its priority problem. For example, a lender searching under the debtor's driver's license name, using the filing office's standard search logic, might not pick up a prior filing under a slightly different name that appears on the debtor's birth certificate, yet a court might well give priority to the earlier filing on the ground that the name appearing on a birth certificate should qualify as the debtor's "exact full legal name"-by analogy to the rule governing corporate debtors. In the example, both lenders would be perfected under the "safe harbor" rule, but the earlier filer would have priority under the first-to-file rule of 9-322. The 'only if' rule should solve this problem."
What Does the Case Law Tell Us? Since Revised Article 9 became effective around the country in 2001, eleven reported cases-all decided between 2003 and 2007-have emerged on the individual debtor name issue. They all wrestle with the requirement of 9-503(a)(4)(A) that a financing statement provide the "individual name of the debtor." The cases recognize that, in sharp contrast to the treatment of entity debtors like corporations, the statute provides no clear standard to determine the name of an individual debtor. Instead, in conclusory fashion, the model form for financing statements found in 9-521 simply refers to the "DEBTOR'S EXACT FULL LEGAL NAME." So, in the absence of statutory guidance, the courts recognize that they are required to grope for a standard that provides some certainty for filers and searchers. Though the courts have done a pretty good job, there are some glaring exceptions.
The Kansas and Nebraska cases. Curiously, six of the 11 decisions come from the Sunflower State, and a seventh comes from its neighbor to the north. The first decision out of the box was In re Irwin, 50 UCC Rep.2d 933, 2003 WL 21513158 (Bankr. D. Kan. 2003), where the trustee in bankruptcy challenged a financing statement filed under the name "Mike Irwin." The debtors full name was "Michael A. Irwin." The court in effect held that nicknames are okay, and relied on a "supplemental database" search that should not have been considered as part of the Kansas filing office's "standard search logic." Given Article 9's reference to "exact full legal name" and its abhorrence of "trade names" (i.e. business nicknames), the Irwin decision was dead wrong.
Fortunately, the Irwin decision was overruled by a later Bankruptcy Appellate Panel decision from Kansas, In re Kinderknecht, 308 B.R. 71, 53 UCC Rep.2d 167 (BAP 10th Cir. 2004). In that case, a trustee voided a financing statement that designated the name of the debtor as "Terry J. Kinderknecht." The court viewed the debtor's "exact full legal name" as "Terrance Joseph Kinderknecht." The BAP rejected the sufficiency of nicknames on the ground that searchers should not have to "guess any number of nicknames that could exist" for an individual debtor.
Then, in Pankratz Implement Co. v. Citizens Nat'l Bank, 130 P.2d 57 (Kan. 2006), the Kansas supreme court stressed the importance the debtor's "exact full legal name," even though the case involved a simple misspelling of the debtor's last name. The decision resolved a priority battle between two secured parties. The first filer misspelled the debtor's name as "Rodger House," while the later filer correctly designated the debtor as "Roger House." The Kansas supreme court noted that, under the "standard search logic" test of 9-506, the later filer could not pick up the first filer's financing statement by searching under the correct name, "Roger House." With wisdom, the court said: "We believe the language used by the Legislature and the intent behind the adoption of the most recent amendments had the effect of shifting responsibility of getting the name on the financing statement right to the filing party, thereby enabling the searching party to rely upon that name and eliminating the need for multiple searches using variations of the debtor's name." (Citing Pankratz, an Idaho decision that invalidates a simple misspelling of the debtor's last name is In re Fuell, 64 U.C.C. Rep.2d 722, 2007 WL 4404643 (Bankr. D. Idaho 2007)(secured creditor misspelled debtor's last name as "Andrew Fuel")).
After the 10th Circuit BAP and Kansas supreme court weighed in, the Kansas bankruptcy courts have had little difficulty in rejecting nicknames on financing statements. In re Berry, 61 U.C.C. Rep.2d 95, 2006 WL 2795507 (Bankr. D. Kan. 2006)(trustee knocks out financing statement that designates debtor as "Mike Berry, Jr." when the debtor's legal name was "Michael R. Berry, Jr."); In re Jones, 2006 WL 3590097 (Bankr. D. Kan. 2006)(creditor filed under "Chris Jones" though debtor's "exact full legal name" was "Christopher Gary Jones"). In In re Stewart, 2006 WL 3193374 (Bankr. D. Kan. 2006), the financing statement designated the debtor as "Richard Stewart," though the debtor's full legal name was "Richard Morgan Stewart, IV." Applying the standard search logic for Kansas, the court held that a "full legal name" requires, at a minimum, the given first name, the first initial of the given second name, and the surname.
Though the later Kansas cases properly reject nicknames on financing statements, both the Berry and Stewart decisions find that the best source for an individual name is the name on the bankruptcy petition-a questionable conclusion that was a major catalyst in moving Texas in the direction of its driver's license amendment.
A good case from Nebraska also rejects nicknames. In re Borden, 353 B.R. 886 (Bankr. D. Neb. 2006), involved a priority conflict between an implement company's PMSI in two pieces of farm equipment and the competing security interest of a later-filed bank. The implement dealer filed under the name "Mike Borden," while the bank filed under "Michael R. Borden." Following Kinderknecht, the Nebraska bankruptcy court invalidated the implement dealer's use of the debtor's nickname, even though the debtor frequently signed legal documents as "Mike Borden."
Non-Anglo name cases. Two of the eleven cases involve non-Anglo names. In All Business Corp. v. Choi, 634 S.E.2d 400 (Ga. Ct. App. 2006), the court found that the debtor's correct name was "Sang Woo Gu." Therefore, a secured party that filed under "Gu, Sang Woo" was unperfected. It appears that the secured creditor may have misinterpreted an Asian cultural naming convention in designating the name of the debtor. In Corona Fruits & Veggies, Inc. v. Frozsun Foods, Inc., 48 Cal. Rptr.3d 868, 60 UCC Rep.2d 1399 (Cal. Ct. App. 2006), the secured party filed a financing statement identifying the debtor as "Armando Munoz." The debtor's full name, as reflected on his INS green card, bankruptcy petition and photo ID, was "Armando Munoz Juarez. The court noted that the debtor's last name was "Munoz" under the Mexican naming convention; however, under the California naming convention, his last name was "Juarez," his city of origin. Therefore, the financing statement was seriously misleading. The case appears to reflect filing error.
The horrid Fifth Circuit decision. Unfortunately, the most recent decision on individual debtor names comes from a very high court and reflects a woeful lack of understanding about individual debtor names under Article 9. Peoples Bank v. Bryan Brothers Cattle Co., 504 F.3d 549 (5th Cir. 2007), involved a priority dispute between two banks, each of which claimed a non-purchase money security interest in the debtor's cattle. The first bank to file, Cornerstone Bank, designated the debtor by his nickname, "Louie Dickerson." The second bank, Peoples Bank, filed using the debtor's formal name, "Brooks L. Dickerson." The Fifth Circuit concluded that the first bank's financing statement was not seriously misleading, even though it used a nickname. The court hinged its decision on a "purposive" reading of Article 9: "The purpose of the filing system is to give notice to creditors and other interested parties that a security interest exists in the property of the debtor….Perfect accuracy, however, is not required as long as the financing statement contains sufficient information to put any searcher on inquiry." 504 F.3d at 559. The court further found that Peoples Bank was on "inquiry notice" because the debtor held himself out to the community as "Louie Dickerson" and frequently used his nickname in business affairs.
The Fifth Circuit decision is way off-base because a secured creditor's actual or constructive knowledge of nicknames is irrelevant, just as knowledge of a competing financing statement can't cure fatal defects in that filing. The filing rules of Revised Article 9 opt for certainty and predictability, and they flatly reject an "inquiry notice" approach to priorities between filed financing statements. The Fifth Circuit also ignored Article 9's third-party searcher test for determining whether a filing is "seriously misleading." The Peoples Bank case reminds us of an equally scary pre-Revised Article 9 decision from the Fifth Circuit holding that a debtor's trade name was okay in a financing statement. In re McBee, 714 F.2d 1316, 36 UCC Rep. 1473 (5th Cir. 1983).
Some Lessons from the Case Law. We can distill some interesting points from this case law:
- At least two of the 11 cases involve simple filer error in the form of misspelling of the debtor's last name. These are not really "individual debtor name" cases, and the misspelling problem can arise just as easily when the debtor is an entity.
- Six of the cases involve agricultural credit, reflecting the fact that most ag debtors operate as sole proprietorships.
- The individual debtor name problem is not a "consumer" problem because secured consumer finance usually involves purchase money security interests, which are automatically perfected, without the need for any filing. In consumer motor vehicle financing, the security interest is perfected by noting the lien on the certificate of title instead of a financing statement. So the individual name problem on financing statements is almost exclusively a "business debtor" problem. (For further discussion of certificate of title debtor name issues, see Clark & Clark, The Law of Secured Transactions Under the UCC, ¶15.05).
- Six of the cases involve a bankruptcy trustee's challenge to the secured creditor's perfected status. Four of the cases involve priority disputes.
- Nine of the decisions are consistent in requiring the debtor's "exact full legal name" and rejecting nicknames. Of the two decisions okaying nicknames, the Kansas case has been overruled by subsequent cases. Because it involved a priority conflict, the Fifth Circuit decision remains as a big problem, even in Texas with its driver's license "safe harbor" amendment.
The "Only If" Approach is the Way to Go. In the interest of simplicity, certainty and predictability, both the "safe harbor" and "only if" approaches seem preferable to the "do nothing" approach. We think the best approach for the Joint Review Committee is the "only if" alternative.
A real-life example from Texas. To prove the point, consider this real-life example of a classic priority dispute between two secured creditors who loaned big bucks to a Texas business run as a sole proprietorship. The first creditor filed a financing statement based on the exact name of the debtor as it appeared on his birth certificate. Several years later, the second creditor did a search under the debtor's slightly different driver's license name, and that search did not pick up the first creditor's financing statement. The 2007 Texas amendment was in effect at the time of the second filing, but not the first. Who had priority? The first creditor contended that the birth certificate filing indicated the debtor's "exact full legal name," if ever there was one. The 2007 amendment, even if applicable to both filings, was only a "safe harbor," not an "only if." The second filer focused on the 2007 amendment and argued that the name on the driver's license was the exclusive legislative standard in Texas, even if it didn't contain "only if" language. The dispute was ultimately settled short of litigation. In our opinion, the "only if" approach would clarify such muddy waters and discourage priority litigation. It is also more likely to put the Fifth Circuit decision into oblivion.
The commercial and political realities. The commercial reality is that the secured lending industry, particularly the banks, is the interest group most directly affected by the Joint Review Committee's choice. That industry has spoken loud and clear to the Committee that it needs the "only if" option so that searchers will have maximum certainty of their priority. It's significant that Texas bankers want to shift from their current "safe harbor" nonuniform rule to an "only if" uniform rule. As part of an "only if" approach, the amended statute will need to provide rules covering (1) expired driver's licenses, (2) changes in name on a license, and (3) what documents satisfy the name requirement if the debtor has no driver's license, i.e. a documentary "waterfall." A transition rule should be added that gives secured creditors five years (corresponding to the deadline for continuation statements) to make any change to the driver's license name.
Perhaps most important, the political reality is that the American Bankers Association and state bankers associations are likely to seek non-uniform "only if" amendments around the country if the Joint Review Committee fails to do so on a uniform basis. If so, the enactment process for the whole package of Article 9 amendments could get messy indeed.
Bottom Line. The "only if" approach is not perfect, but it's the least imperfect way to deal with the individual debtor name problem in Article 9 of the UCC.
