Beware of Hidden Liens
by Sue Murphy and Sakina Rasheed
Whether you are representing a secured lender, litigant, purchaser, debtor, or a client in bankruptcy, understanding whether the assets at issue are encumbered by liens can be critical. Many people mistakenly believe that UCC, judgment lien, tax lien and real property searches will disclose the universe of potential liens on a borrower’s assets. However, a number of other liens may be lurking, hidden from such searches.
Such “hidden” liens include: (i) agricultural liens, such as trust liens under the Perishable Agricultural Commodities Act (PACA) and the Packers and Stockyards Act; (ii) liens that arise by sale of assets; (iii) liens imposed by operation of law, such as liens of mechanics, materialmen, warehousemen, carriers and landlords; (iv) security interests in assets that can be perfected by control, such as deposit accounts and securities accounts; and (v) security interests in assets that can be perfected by possession, such as goods, instruments, chattel paper, or tangible negotiable documents.
Under a 1984 amendment to PACA, perishable agricultural products are placed in a “PACA trust” and are set aside to pay unpaid suppliers. In Reaves Brokerage v. Sunbelt Fruit & Vegetable, 336 F.3d 410 (5th Cir. 2003), the Fifth Circuit held that PACA protects sellers of perishable commodities by giving them priority over secured creditors. Similarly, in Nickey Gregory Co., LLC v. AgriCap, LLC, 597 F3d 591 (4th Cir. 2010), the Fourth Circuit held that an unpaid supplier of perishable agricultural products had a superior interest in the accounts receivables and proceeds held by a secured lender.
The interests of such unpaid suppliers may not appear on a lien search. Practitioners should be mindful of dealing with debtors in the agricultural industry and be aware that a secured lender’s security interest could be trumped by an unpaid supplier.
Another category of “hidden liens” can be discovered through searches, but not through the typical UCC, judgment lien, tax lien, or real property lien searches. Examples include: (i) liens on copyrights, patents, and trademarks; (ii) property tax liens; (iii) aircraft liens; (iv) liens on manufactured homes; and (v) maritime liens.
Another type of “secret” lien can also arise when a debtor has interacted with the U.S. Government. Certain government contracts include a clause that vests “title” in a contractor’s materials and special tooling equipment in the Government. The Government often relies on these title-vesting clauses to support a claim that it holds a superior interest in these assets over other lenders. Often, a subsequent lender is surprised to learn that the Government may have a super-priority lien on the debtor’s inventory, without the Government ever having filed a financing statement.
The U.S. Court of Claims held in Marine Midland Bank v. United States, 687 F.2d 395, 36 UCC Rep. 968 (Ct. Cl. 1982), cert. denied, 460 U.S. 1037 (1983), that “title vesting” clauses in government contracts give the Government an interest closely analogous to a purchase money security interest, and these interests prevail over the interest of a general creditor on unrelated debt. The court analogized the Government’s interest to a PMSI without much further analysis, other than stating that the “the government should be able to take out of the contractor the value that it has put in, if that value is identified with specific property.” The court later held in First National Bank of Geneva v. United States, 5 UCC Rep. 2nd190, 13 Ct. Cl. 385 (1987) that a secured lender may have priority over the Government if it properly perfected a PMSI. Arguably, a lender facing a challenge by the Government would need to provide evidence tracking that its loan funds were used to purchase the inventory at issue.
A secured lender may avoid being surprised by a lurking super-priority government lien by determining whether the debtor has a contractual relationship with the government.
A thorough knowledge of the debtor’s industry and the related business relationships can help lead counsel in the right direction so that the appropriate due diligence can be conducted to uncover “hidden liens.”