Opting in to UCC Article 8 by Partnerships and Limited Liability Companies
A foreign business entity looking to enter the U.S. market will in many instances create a U.S. subsidiary through which it will manage its operations and hold title to U.S. assets. The U.S. subsidiary may require a line of credit to finance its working capital needs. Obtaining its own domestic credit facility independently of the foreign parent may be more cost effective than obtaining financing abroad1. To improve its creditworthiness and negotiating strength with lenders, the U.S. subsidiary should undertake, in advance of entering into the credit facility, standard corporate planning and clean up of its assets. In some circumstances, the interplay of Article 8 and Article 9 of the Uniform Commercial Code (the “UCC”) offers an opportunity to enhance the collateral value of the equity interests in the U.S. subsidiary to be pledged by the foreign parent in connection with a guaranty of the loan. If the choice of entity for the U.S. subsidiary is a partnership or limited liability company, the foreign parent should consider placing in the charter documents of the U.S. subsidiary an express “opt-in” to Article 8 of the UCC. Such an election may be viewed by a lender as enhancing the value of the U.S. subsidiary’s partnership or limited liability company interests because it will potentially place the foreign parent’s collateral pledge of such interests in a stronger position in terms of perfection and priority under Article 9 of the UCC.
Security Interests under Article 9 of the Uniform Commercial Code
In U.S. jurisdictions, UCC Article 9 is the law of secured transactions, governing the granting of security interests in a debtor’s personal property and the subsequent perfection and priority of the security interest.2 Section 9-109(a) sets forth the general scope of Article 9, which applies to, among other things, “a transaction, regardless of its form, that creates a security interest in personal property . . .”
Under Article 9, a security interest is enforceable against a debtor and third parties if it has attached. Section 9-203 provides that attachment occurs when (i) the debtor has given value for the collateral, (ii) the debtor has rights in the collateral or the power to transfer rights in the collateral to a secured party, and (iii) the debtor has authenticated a security agreement that provides a description of the collateral. Section 9-108 provides that the description of the collateral is sufficient if it has been reasonably identified. A fundamental feature of Article 9 is that it provides defined descriptions of collateral assets by classifying them into various types3. Understanding the different collateral asset types is critical because the rules of perfection and the priorities of a secured party and other creditors are then determined based on the classification. This is especially the case with a partnership or limited liability company interest since, through the application of the opt-in election under Article 8, such an interest may shift between collateral types, with potentially disastrous effect for a lender.
The stock of a corporation is classified as investment property through the interplay of Section 8-103(a) and Section 9-102(a)(49). It does not follow, however, that partnership and limited liability company interests are investment property subject to the same rules of perfection and priority as corporate stock. Rather, unless there is an election to be covered by Article 8, partnership and limited liability company interests fall into the residual or catch all category of general intangible property4. This is the case even if the partnership or limited liability company interest is represented by a certificate; the interest remains a general intangible, and under Section 9-310, the security interest in a general intangible can only be perfected through the proper filing of a financing statement. Although perhaps counterintuitive, possession or control of the certificate will not result in perfection so long as the interest is classified as a general intangible.
Following the creation of a security interest, the lender must perfect the interest through at least one of various methods – filing, possession or control to maximize its rights in the collateral against third parties. While the debtor and secured party will contractually agree to the choice of law of a particular U.S. jurisdiction and the UCC as in effect in that jurisdiction, Section 9-301 provides that for purposes of perfection, one must generally look to the law of the debtor’s location. In the case of perfection effected through the filing of a financing statement on Form UCC-1, it would be filed in the designated filing office for that particular jurisdiction5, generally the secretary of state in most states. In the case of a non-U.S. corporate parent as debtor pledging the partnership or limited liability company interests of its U.S. subsidiary to secure the parent’s guaranty of a credit facility, its default location, pursuant to Section 9-307, is Washington, D.C., and the filing office there is the Office of Tax and Revenue, Recorder of Deeds6. Under Section 9-322, once a financing statement has been filed, the lien of the secured party has priority over all secured parties filing after it.
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