When financing an SBA loan, lenders often conduct UCC searches to prove that they will have a first lien on the borrower's business assets. When lenders review the search results, they often find financing statements in place that the borrower and/or guarantor claim relates to financing that has been previously paid in full.  Unfortunately, relying on a borrower or guarantor's word when it comes to lien priority issues may result in a repair or denial of an SBA guaranty. 

In a recent court decision, Deere & Company v. New Holland Rochester, Inc.,No. 25A05-1006-CC-367, (Court of Appeals - Indiana) October 12, 2010,  the Court reinforced the position that the UCC-1 record system is only a means to provide secured parties with notice of liens, and it is the secured party's duty to confirm the existence and scope of liens against a potential debtor.  In Deere & Company, a borrower had purchased two pieces of equipment from Deere & Company, which were subject to a properly perfected purchase money security interest in favor of Deere ("Deere Equipment").  The borrower then entered into a transaction with New Holland Rochester, Inc, which involved trading the Deere Equipment to New Holland.  Prior to completing the transaction, New Holland conducted a lien search on the borrower and discovered Deere's lien on the Deere Equipment.  Relying on statements from the borrower and the borrower's bank that the Deere Equipment financing was paid in full, New Holland completed the transaction and took possession of the Deere Equipment.  Soon thereafter, Deere filed an act of replevin against the borrower and New Holland claiming that the borrower had defaulted on its loan and Deere was entitled to possession of the Deere Equipment.  On appeal, the Court found in favor of Deere and New Holland was forced to turn over the Deere Equipment.

The Court held that, "...as a general rule, we find that it is unreasonable to rely on the statements of third parties or the debtor about the current status of security interests...there is simply no excuse for New Holland's failure to contact Deere directly. Its decision to rely on statements made by a third party removes any defense it may have had as a bona fide purchaser."

While lenders often rely upon the borrower's statements that equipment financing is paid off or that the existing secured party will terminate its financing statements post closing, the best practice is for a lender to accept only written confirmation from the secured party of record that it has no lien or security interest in the collateral of a borrower. 

Under 9-513 of the Uniform Commercial Code, a secured party must send a debtor a termination statement for a filed financing statement or file the termination statement in the filing office within 20 days after a secured party receives authenticated demand from a debtor, if there is no obligation secured by the collateral covered by the financing statement and no commitment to make an advance, incur an obligation or otherwise give value.   The UCC does not give a Lender who has paid off the borrower's debt owing to an existing secured party the authority to terminate that existing secured party's financing statement. 

Therefore, lenders should require a written confirmation from each secured party of record that it has no lien against the borrower and authorization for the Lender to file a UCC-3 to terminate existing secured party's lien, or have the existing secured party provide a copy of its recorded UCC-3.  For existing secured parties who will be paid off at closing, Lenders should require a payoff letter which, in addition to providing a payoff amount, also states that upon receipt of the payoff amount, the secured party's lien on and security interest in all of the borrower's assets will be released and terminated.