What is a purchase money security interest (PMSI)?

How is a PMSI obtained for non-inventory collateral?

To obtain purchase money super priority in goods other than inventory, livestock, and fixtures — such as equipment collateral — the creditor must satisfy two requirements:

1. The credit extended by the creditor must be used by the debtor to purchase the collateral; and
2. The creditor must properly file a financing statement covering the collateral when the debtor receives possession of the collateral or within 20 days thereafter.

To meet the second requirement, the creditor must determine when the debtor takes possession of the collateral. If the 20-day timeframe is not complied with, the creditor will not obtain super priority for its security interest. The creditor must also consider scenarios where collateral is received in installments.

For instance, courts may consider the 20-day period to run from when most of the collateral was received as opposed to the last installment. In In re Piknik Products Company, Inc., 346 B.R. 863 (Bankr. M.D. Ala. 2006), the court found that the secured party failed to perfect its interest within 20 days after the debtor received possession of the “majority” of the equipment, and rejected the secured party’s argument that the entire installation was not yet complete.

To avoid this situation, the creditor should consider pre-filing before the collateral is delivered.

How is a PMSI for non-inventory collateral perfected?

A non-inventory PMSI is perfected by filing a UCC-1 prior to the debtor taking possession of the assets or within 20 days after receipt. This must be done in the appropriate jurisdiction where the debtor is located. For registered organizations, the location of the debtor is the jurisdiction of the debtor’s organization. If the filing takes place after the 20-day period, the filer will not have PMSI priority and will come in line after the prior-perfected security interests.

These are general steps, you should look at state statutes on PMSI perfection since these can vary from state to state.

What are the PMSI requirements for inventory?

To perfect purchase money security interests in inventory, Section 9-324(b) requires that:

• The PMSI must be perfected at the time the borrower takes possession of the inventory. As such, the security agreement and value extended must occur before inventory is received.
• The secured party must provide authenticated notification to holders of conflicting security interests before perfection — this includes every known secured party. This notice must be received within five years prior to the borrower obtaining possession of the inventory.
• The notification must state that the person sending the notification has or expects to acquire a PMSI in the borrower’s inventory and describe the inventory.

Furthermore, to constitute a PMSI, the UCC stipulates that a “close nexus” must exist between the acquisition of collateral and the secured obligation. In other words, the borrower cannot acquire collateral and subsequently create a security interest. A “close nexus” would also extend to related obligations, which may include but are not limited to interest, fees, insurance, and similar related expenses.

To meet these requirements, due diligence from the outset is essential. It’s also important to retain copies of all delivery records, including invoices, purchase orders, etc.

Finally, it’s important to note that PMSI in inventory has limited reach into “proceeds”. As such, cash proceeds cannot be reached through a PMSI filing unless the identifiable cash proceeds are received on or before inventory is received by the buyer.

How is a PMSI in inventory perfected?

To perfect a PMSI in inventory, creditors must take the following steps:

1. Conduct a UCC search in the applicable jurisdiction to identify the borrower’s secured creditors and collateral.
2. Prior to the debtor’s receipt of the collateral, file a UCC-1 that identifies goods to be sold as collateral.
3. Provide written notice to the holders of conflicting perfected security interests in the debtor’s inventory. The notice must be received no more than five years before the debtor receives inventory and the notice must include PMSI language as required under the UCC.

A financing statement must be continued within six months before its expiration date, which for an initial filing is usually the five-year anniversary from the date of the original filing. Prior to filing a UCC-3 continuation, the filer would also need to conduct another UCC search to determine if the statements of the conflicting security interest holders remain effective or have been assigned to someone else. If the statements are still effective, the secured party must send new PMSI notices to those holders to retain its PMSI status.

Again, these are general steps. You should look at state statutes on PMSI perfection since these can vary from state to state.

What are the benefits of a PMSI?

PMSI is a useful tool that benefits the PMSI lenders, existing lenders, and borrowers.

• The PMSI lender benefits by making the loan and getting first priority to the underlying assets.
• The debtor wins from being able to finance the assets. Without the PMSI the debtor may not have been able to purchase the collateral, or would have had to obtain a loan at less favorable terms.
• The existing lender with first priority to the debtor’s assets beyond those secured by the PMSI benefits from the debtor gaining access to additional funds in order to obtain inventory/equipment essential for the operations of the debtor, making it more likely the debtor will be successful and able to pay back its loan.

Conclusion

Priority order can determine whether a loan debt gets repaid or not. Creditors with first priority naturally stand a better chance of being able to collect against a debtor compared to those who file late or fail to secure their claim at all.

However, a creditor with a PMSI can gain priority over previously perfected security interests as long as they properly meet UCC Article 9 criteria.

Learn how CT Corporation can become your partner for the most accurate UCC filing services. Contact CT Corporation today.