On October 3, 2014, the US Bankruptcy Court for the Western District of New York, in In re Sterling United, Inc., held that a "needlessly convoluted description of collateral" in successive financing statements, which referred to the debtor's previous address, did not cause the financing statement to become seriously misleading under section 9-506 of the Uniform Commercial Code (UCC) and ineffective to perfect a security interest, even though the secured party failed to update the collateral description with the debtor's new address (No. 13-11351, (Bankr. W.D.N.Y. Oct. 3, 2014)).

Between 2005 and 2007, First Niagara Bank (First Niagara) advanced about $1.2 million to United Graphics, Inc. (Debtor). First Niagara took a security interest in all of the Debtor's assets and properly perfected the interest by filing a financing statement.

Under the UCC, the security agreement must contain a description of the collateral that reasonably identifies what is described (NY UCC § 9-108(a) and § 9-203(b)(3)(A)). Although an "all assets of the debtor" collateral description cannot be used in a security agreement, it can be used as a description of collateral in the financing statement if the deal covers all the debtor's assets (NY UCC § 9-504(2)). The collateral description on the financing statement filed by First Niagara included the language: "all assets of the Debtor... including, but not limited to, any and all equipment, fixtures, inventory, accounts... and located at or relating to the operation of the premises at 100 River Rock Drive, Suite 304, Buffalo, New York..."

In 2012, the Debtor changed its name and address. First Niagara properly filed amended financing statements reflecting the change in name and address, but failed to change the Debtor's address noted in the description of the collateral.

In February 2013, while the Debtor's loan was in default, First Niagara changed the collateral description in the financing statement to reflect the Debtor's updated address and to change the wording at issue to "including but not limited to those located at or used in connection with the business premises at..."

On May 17, 2013, the Debtor's creditors commenced an involuntary Chapter 7 proceeding against the Debtor. By the time of the filing, First Niagara had already began to liquidate its collateral.

The Chapter 7 trustee brought an action alleging, among other causes of action, that:

The Trustee argued that the filings were ineffective under section 9-506 of the UCC and that after the Debtor's move, they failed under section 9-507 of the UCC. The Trustee sought to recover payments made by the Debtor to First Niagara and proceeds from collateral liquidated by First Niagara.

The Bankruptcy Court denied the Trustee's cross-motion as to section 544 of the Bankruptcy Code and section 547 of the Bankruptcy Code and upheld the claim of security.

First, the Court examined the Trustee's argument that transfers made prior to the preference period were avoidable under section 544 of the Bankruptcy Code. Stating that the Trustee concentrated too much on the "filings" as opposed to the grant of the lien, the Court found that the grant of security interest is not avoidable under section 544 of the Bankruptcy Code.

Second, the Court examined the claim that the financing statement was seriously misleading and therefore that transfers made within the preference period were avoidable under section 547 of the Bankruptcy Code. The Court declined to adopt the Trustee's assertion that the collateral was limited to assets related to the Debtor's prior place of business because "it is obvious that the intended structure of the language" was to cover "all assets of the Debtor, including X, Y and Z, located at 100 River Rock Drive, but the collateral is not limited to X, Y, and Z."

Even if the collateral description was ambiguous, the Court noted that the result would be the same. The Court acknowledged that there were two possible lines of reasoning it could adopt in determining whether errors in the description of collateral in the financing statement could make it "seriously misleading" under the UCC:

The Court rejected In re Durbin as too broad and elected to adopt the line of reasoning under In re Strickland. Whether the potential creditor is a lender, lien creditor or bankruptcy trustee, the Court said that a court must presume a certain level of sophistication, intelligence and diligence in reading the collateral description in the financing statement and acting upon the notice it provides. The Court recognized that when searching for filings against a debtor's name, the UCC generally requires a standard of reasonableness or prudence from the searching party. The Court chose to extend that same standard to examining the collateral description.

Since the succession of publicly filed financing statements adequately described the name and address changes, the Court held that a reasonable or prudent search of the UCC filings would put any potential creditor on notice of the lien and the relocation of collateral to the new address. Notice filing jurisdictions, such as New York, only require that a filing put a potential creditor on notice that another creditor may have a security interest in the assets, which gives the potential creditor a starting point for its investigation into whether the assets are indeed encumbered. Here, the successive financing statements should have triggered a further search by reasonable potential subsequent creditors. Therefore, the ambiguity concerning the Debtor's address in the collateral description did not cause the financing statement to be seriously misleading or ineffective to perfect First Niagara's security interest in the collateral.

The Court also held that neither the UCC nor the Bankruptcy Code grant a trustee any special status as to what constitutes "seriously misleading" under section 9-506 of the UCC.

This case offers two pieces of practical advice for counsel. First, in an "all assets" deal, counsel should avoid superfluous descriptions of collateral in their financing statements. Under the UCC, a collateral description in a financing statement which consists only of "all assets of the debtor now owned or hereafter acquired" is typically sufficient if that is the deal between the parties. Adding additional details may create uncertainty and increase the possibility of litigation later.

Second, potential creditors should examine filings and be aware that they will be responsible for making reasonable inferences from the information provided by the financing statements. The filings provide a starting point for the potential creditor's further investigations.