Tuesday, January 5, 2010

The Uniform Commercial Code or UCC

If you have talked with any funding sources or colleagues who factor, you have probably heard about the UCC...and you may be wondering: What the heck is it?

First published in 1952 after ten years of development, the UCC was designed to harmonize interstate trade. It deals with personal (moveable) versus real (immovable) property and is a guideline for transacting business. The overriding philosophy of the Uniform Commercial Code is to allow people to make the contracts they want, but to fill in any missing provisions where the agreements they make are silent. It also seeks to impose uniformity and streamlining of routine transactions like the processing of checks, notes, and other routine commercial paper.

There are separate sections that deal with different aspects of commercial transactions broken down as follows:

1General ProvisionsDefinitions, rules of interpretation
2SalesSales of goods
2ALeasesLeases of goods
3Negotiable InstrumentsBanknotes and drafts (commercial paper)
4Bank DepositsBanks and banking, check collection process
4AFunds TransfersTransfers of money between banks
5Letters of CreditTransactions involving letters of credit
6Bulk Transfers and Bulk SalesAuctions and liquidations of assets
7Warehouse Receipts, Bills of Lading, and other Documents of TitleStorage and bailment of goods
8Investment SecuritiesSecurities and financial assets
9Secured TransactionsTransaction secured by security interests

The main Article factoring companies use is Article 9: Secured Transactions. Factoring companies will typically file a UCC-1 financing statement securing an interest (filing a lien) in the assets of a business for which it intends to fund. This statement outlines what collateral is being secured. For an equipment leasing company financing, say, a packaging machine, a typical UCC-1 statement would list that piece of equipment as the sole item secured. Most factoring companies will file what is called a "blanket" UCC-1 to secure all assets of the business. It is similar to the statement a bank would file if a business were to obtain a secured line of credit.

Many factoring companies file their UCC-1 at the time a business submits an application which would force that business to have the filing terminated should they choose to work with another financing company.

*When contemplating which factoring company to work with, make sure you consider those that file their UCC-1 only at the time you sign a proposal outlining the terms of the relationship, not when you submit an application.

When a factoring relationship comes to an end and the factor has been paid back all funds advanced, a business will need to make sure they obtain a UCC-3 financing statement release. This is a document stating that the company which held the security in the business no longer has any rights to the underlying assets. This will free a business to find other financing and remove that particular lien.

A given business may have many UCC-1s filed on it and the secured parties (financing companies or individuals) hold different priorities depending upon when they filed. For example, XYZ Corp. has three blanket UCC-1s filed. One by ABC Bank, one by 123 Factors, and one by John Doe (the former owner who is financing the purchase for the new owner). Assuming that ABC Bank filed on January 1st, 123 Factors filed on February 1, and John Doe filed on March 1, ABC Bank would hold the first position, 123 Factors would hold the second position, and John Doe would hold the third position. What this means is that in the event of a bankruptcy on the part of XYZ Corp., the first position holder would be paid back first, the second position holder would be paid back second, etc. so long as the underlying collateral would provide enough value to make repayment an option.

Almost all factoring companies require that they hold a first positon UCC-1. There are a select few out there which do not require a UCC-1 to be filed, but beware that these companies are advancing funds without a security in a business so they may be more inclined to make frequent and aggressive calls to your customers and actively pursue their first line of offense - a personal guarantee. The personal guarantee is used as, at most, a secondary right for financing companies to recoup if they have a UCC-1 filed.

The UCC is in place to help all parties to commercial transactions and actually supports a factoring client's ability to obtain financing. Factoring companies are mainly interested in the accounts receivable as collateral and will usually, without issue, subordinate their security interest in other assets to other lenders.

To view the UCC in its entirety, please visit: http://www.law.cornell.edu/ucc/

If a business currently has a factor or bank funding them, odds are the financing company has filed a UCC-1 to secure its position. Should a business decide to change financing companies one of two things will need to happen: 1) a subordination of the existing lender's UCC-1 to the new company (sometimes a limited subordination will work, but most frequently a full subordination is required moving the old lender into a lower position and the new lender into first), or, 2) the new lender will need to payoff the old lender.

More on this in the next post...

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