On November 7, 2013, the US Court of Appeals for the Sixth Circuit, in 1st Source Bank v. Wilson Bank & Trust, held that the lender only had an unperfected subordinate security interest in the collateral consisting of accounts receivable. The UCC-1 financing statements filed to perfect the lender's security interest under the Uniform Commercial Code (UCC) did not mention accounts or accounts receivable and, although they did include the UCC term "proceeds" in the collateral description, this term does not include revenues earned from the use of the collateral and does not include accounts receivable.

In late 2004, 1st Source Bank (1st Source) entered into a series of financing agreements with K&K Trucking and J.E.A. Leasing (Debtors). In connection with the financing, the Debtors entered into security agreements which granted 1st Source a security interest in the Debtors':

1st Source subsequently filed financing statements under the Tennessee UCC which identified the collateral as the specified tractors and trailers, certain collateral related to the equipment and "all proceeds thereof, including rental and/or lease receipts." The financing statements did not mention accounts or accounts receivable.

After 1st Source filed its financing statements, Wilson Bank & Trust and other lenders (Wilson) entered into financing transactions with the Debtors and properly filed financing statements that listed, among other things, "all accounts receivable now outstanding or hereafter arising."

In 2009, the Debtors defaulted on their loans and 1st Source took possession of certain collateral while Wilson took possession of the accounts receivable. 1st Source brought suit to recover the accounts receivable, arguing that although it had omitted to list accounts or accounts receivable in its financing statements, it had a first priority perfected security interest in that collateral because the language "all proceeds thereof" used in its financing statements included the accounts receivable.

It is undisputed that 1st Source had an attached security interest in the Debtor's accounts. However, to have first priority to the collateral against subsequent secured parties, the security interest must also be perfected (see Practice Note, UCC Creation, Perfection and Priority of Security Interests). In order for 1st Source to perfect its security interest in the accounts receivable under Chapter 9 of the Tennessee UCC, the lender must properly file a financing statement that describes the collateral to be covered (UCC § 9-502(a)(3)). The financing statement provides notice to third parties of the lender's superior claim to that collateral.

The US District Court for the Middle District of Tennessee granted Wilson's motion for summary judgment, holding that 1st Source's financing statements were not sufficient to put Wilson on notice that 1st Source had a security interest in the Debtors' accounts receivable. The court held that, as a matter of Tennessee law, the term "proceeds," as used in a financing statement, does not include accounts receivable. 1st Source appealed.

The US Court of Appeals for the Sixth Circuit noted that, under Tennessee law, more specific statutory provisions trump more general provisions and that statutes should be construed in a manner that renders no part of the statute superfluous. Under Chapter 9 of the Tennessee UCC, the term proceeds had a specific statutory definition, which includes, among other things "whatever is collected on, or distributed on account of, collateral" as well as "rights arising out of collateral."

While 1st Source argued that these definitions included the Debtors' accounts receivable arising from the use of the collateral, the Sixth Circuit disagreed. Dismissing 1st Source's arguments, the Sixth Circuit found that:

Affirming the District Court's decision, the Sixth Circuit held that, for rights to arise out of collateral, they must result from a loss or dispossession of the party's interest in the collateral and not simply by its use. The court supported the proposition that revenues earned from the use of collateral are not proceeds. The Sixth Circuit found no support for 1st Source's overly broad interpretation of "proceeds" and declined to adopt it.

Accordingly, because 1st Source's financing statements did not expressly refer to accounts in the collateral description, they were insufficient to put Wilson on notice of its security interest in the accounts receivable and the Sixth Circuit held that 1st Source only had an unperfected security interest in this collateral, subordinate to Wilson's perfected security interest.

This court's decision that proceeds do not include accounts will certainly be of concern to lenders. In any event, this case serves as a reminder that financing statements used to perfect a lender's security interest in certain collateral must carefully identify the collateral with specificity.

If the lender is receiving a security interest in specific assets, the lender should be careful that the collateral description in its financing statement mirrors the collateral description contained in the security agreement. If any portion of the collateral is not adequately described in the UCC-1 financing statement, the lender's security interest in it may not be perfected and its security interest may be subordinated to another secured party's properly perfected interest. In an assets deal, however, it may be appropriate for the lender to rely on an "all assets" collateral description in the financing statement (see Practice Note, UCC: Preparing and Filing Financing Statements).

To be certain that the lender's security interest in specific collateral is properly perfected, practitioners should take special care to ensure that the UCC-1 financing statement reflects the entire set of collateral described in the security agreement. This case highlights the risk of relying on general terms such as "proceeds" to identify specific assets such as accounts receivable.