Dot Your I’s and Don’t Forget the T’s: Lender Loses Its Secured Status for Missing ‘T’ in Borrower’s Middle Name

A recent bankruptcy case dramatically illustrates how critical it is for a lender to strictly comply with the requirements for creating a legally effective UCC financing statement, and the hard lessons that follow if a lender fails to do so.
 
In Mainsource Bank v. LEAF Capital Funding, LLC (In re Nay), 563 B.R. 535 (Bankr. S.D. Ind. 2017), the Indiana bankruptcy court held that because the borrower’s middle name on financing statements did not exactly match his middle name on his driver’s license (it lacked one letter: t), LEAF’s financing statements were not effective. Consequently, LEAF lost its collateral to another lender, and it was relegated to general unsecured creditor status in the bankruptcy case.
 
Background of the Case
In February 2014, Mainsource Bank (“Mainsource”) filed a financing statement perfecting its security interest in personal property of Mr. and Mrs. Nay (the debtors) that included equipment. Subsequently, Mr. Nay granted LEAF purchase money security interests in two pieces of equipment that Mr. Nay acquired with financing provided by LEAF. LEAF filed two UCC financing statements that identified the debtor’s name as “Ronald Mark Nay.” The debtor’s name as listed on his most recently issued unexpired Indiana driver’s license was “Ronald Markt Nay.” The difference was a missing “t” at the end of Mr. Nay’s middle name. Perhaps the person at LEAF tasked with preparing the financing statements thought that the “t” was a typo, and the person took the liberty of correcting what appeared to be a misspelling.  If that is what occurred, that was a fatal assumption and it cost LEAF dearly.
 
Under the Uniform Commercial Code (the “UCC”), a creditor that properly and timely perfects a purchase money security interest in equipment will acquire a security interest in that equipment that has priority over other pre-existing secured creditors. The problem for LEAF was that the court found that LEAF had not properly perfected its security interests in the subject equipment because the name on LEAF’s financing statements did not match the name listed on Mr. Nay’s driver’s license.
 
UCC Alternative A and Alternative B
Several years ago, amendments to the UCC allowed states to choose between two alternatives for identifying an individual debtor’s name for the UCC financing statement. The choices are informally referred to as “Alternative A” and “Alternative B”. Forty-four states (including Wisconsin) have adopted Alternative A.
 
Under Alternative A, a financing statement will not be seriously misleading “only if” the financing statement uses the name on the debtor’s unexpired state-issued driver’s license or identification card. [As an aside, the question of what is the correct debtor name for a financing statement can become complicated if the debtor’s driver’s license or identification card later expires (especially if the debtor does not obtain a new one) or the debtor later modifies his/her name on the driver’s license or ID card.]
 
Six states have adopted Alternative B, also known as the “safe harbor alternative.”[1] Under Alternative B, the creditor can look to either (1) the debtor’s individual name as determined under state law; (2) the debtor’s surname and first personal name; or (3) the name on an unexpired driver’s license or other state identification card. Under Alternative B, using the unexpired driver’s license or state identification name on the UCC financing statement provides a “safe harbor” where using that name for the debtor will mean that the financing statement is not seriously misleading, even if the debtor uses different names on other public records or commonly goes by a different version of his/her name than what is on the license or ID card.
 
Application of Alternative A in LEAF Case
Indiana is an Alternative A state, where a financing statement is “seriously misleading” if it fails to provide the name of the individual which is indicated on an unexpired Indiana driver’s license or identification card. In this case, because Mr. Nay’s name listed on the financing statements did not match the name listed on his unexpired driver’s license (fatally missing the letter t), LEAF’s financing statements were “seriously misleading.”
 
However, the UCC contains a general fallback provision that can sometimes redeem an otherwise “seriously misleading” financing statement.  Under this fallback provision, if a search of the financing statement records (in the applicable UCC filing office, using the UCC filing office’s standard search logic) under the debtor’s “correct name” (the debtor’s name as required under Alternative A or B as applicable to the case at hand), discloses the defective financing statement, then the defective financing statement may still be effective to perfect the security interest.  In order for LEAF to be protected by this fallback provision, LEAF needed to demonstrate that its financing statements (that omitted the “t” in the middle name) would show up in a UCC financing statement search under Mr. Nay’s “correct name”: “Ronald Markt Nay”.
 
Unfortunately for LEAF, the UCC search (using the filing office’s standard search logic) under the debtor’s correct name did not reveal LEAF’s financing statements. As a result, LEAF’s security interests in the equipment were unperfected and the equipment LEAF financed became the collateral of Mainsource because Mainsource’s financing statement stated the debtor’s correct name.
 
The court noted that although the result was harsh, the court was “constrained to interpret the statute in a manner consistent with legislative intent, which is ‘to simplify formal requisites and filing requirements.’”
 
Conclusion
The LEAF case demonstrates the significant loss a lender can suffer from a small error, such as a missing “t”, from an individual debtor’s middle name.  The case also demonstrates that such harsh consequences can be avoided by carefully following the rules set out in the UCC for creating and filing a financing statement.  Following those rules can be easier said than done, however, as the UCC rules can vary from state to state and are not always all that clear.  Lenders can minimize exposure by consulting with experienced commercial law counsel to review a lender’s practices and procedures and develop checklists to facilitate the preparation and filing of UCC documents.
 
If you have any questions on the topic of this bulletin or other UCC matters, feel free to contact Attorney Matthew Gerdisch (mgerdisch@kmksc.com) of our office, or call (414) 962-5110
 
This bulletin is provided by Kohner, Mann & Kailas, S.C., for educational and informational purposes only and is not intended and should not be construed to be legal advice.  September 27, 2017.
[1] These states are Alaska, Colorado, Connecticut, Delaware, Nevada, and Wyoming.