Uniform Commercial Code (UCC) search and filing can be a minefield of complexities and jargon to learn. For lenders, one especially beneficial area to learn about is purchase money security interest (PMSI). Unfortunately, PMSI is also one of the most confusing areas of UCC filing. One wrong move, and lenders can lose any advantage to gain first priority. This guide teaches PMSI basics and how lenders can leverage a transaction to achieve a superior position.
What does PMSI mean?
PMSI stands for Purchase Money Security Interest as defined in Section 9-312 of the UCC. It gives secured PMSI creditors a distinct advantage over other creditors who perfected their interest first regarding purchase-money collateral. In simpler terms, a PMSI position allows a secured party to jump to the head of the line relative to the product or inventory.
How a PMSI works
The PMSI holds a favored position under UCC Article 9. If a transaction qualifies as a PMSI, the secured party can achieve a superior position even in relation to other secured parties that have perfected before it. A PMSI is generally a two-party transaction; the supplier or seller of goods retains a security interest for the purchase price. When perfecting a PMSI, there are additional requirements pertaining to notification of prior secured parties and filing deadlines.
Requirements for PMSI
These sections specify the requirements for PMSIs in inventory and non-inventory collateral:
- Inventory – Security interest taken on goods that are being resold to another party for resale (e.g., Black & Decker sells circular saws to Home Depot, who then resells to customers)
- Non-Inventory (Equipment/Machinery) – Security interest taken on a specific piece of collateral, and the debtor retains the equipment (e.g., copier, refrigerator, forklift, printing press)
When inventory is used as collateral, the UCC requires four conditions to be met before a security interest can qualify as a PMSI:
- The PMSI must be perfected at the time the debtor receives possession of the inventory
- The filer must give written notification to the holder of the conflicting perfected security interest in the debtor’s inventory
- The holder of the conflicting security interest must receive the notification no more than five years before the debtor receives the inventory
- The notification must state “that the person giving the notice has or expects to acquire a purchase money security interest in inventory of the debtor, describing such inventory by item or type.”
PMSIs for non-inventory collateral can be achieved with less effort. The notification requirements do not apply.
However, it’s important to note that the secured party bears the burden of proof in determining whether the security interest is a PMSI.
What qualifies for a PMSI?
The jargon can be confusing. Here’s an example of inventory collateral that qualifies for PMSI.
Imagine there is a debtor — a toy manufacturing company called Unique Toys, Inc. — with an existing business loan from Big Bank. Big Bank provides a business loan backed by Unique Toys’ assets and helps the company get off the ground. While the corporation is profitable, it is nonetheless cash-strapped.
A big store has placed a $1 million purchase order with Unique Toys, and to fulfill the order, Unique Toys needs to make a $400,000 advance payment to the factory. Big Bank is unwilling to lend Unique Toys additional funds, but other parties are willing to lend at higher rates for a first position lien on the borrower's assets. The only problem is that Big Bank already has a first-position lien on the property. What can Unique Toys do?
This is the type of scenario where a PMSI can save the day.
Do note that this situation expands to non-inventory collaterals as well. Any secured party who has a PMSI position will be ahead of the bank on that specific collateral.
How to file a PMSI
A security agreement must first be in place to establish a PMSI position. Then, the secured party must follow a prescribed procedure depending on the type of collateral:
Non-inventory
- File UCC-1 within 20 days of taking possession of the collateral
Inventory:
- File UCC-1
- Run a search in the applicable jurisdiction to identify other secured creditors
- Send Notification Letter(s) by Certified Mail to notify any prior secured creditor(s)
- Deliver the inventory collateral
Generally, whoever files a UCC first on the particular collateral is in the first place to reclaim the collateral or its proceeds. Secured parties must look at state statutes on PMSI perfection since these can vary from state to state.
PMSI perfection deadlines differ depending on the type of collateral. In general, the secured party must file the UCC within 20 days of possession of the collateral. The PMSI position is then established on the date of the UCC filing for specific equipment described in the collateral statement.
An exception to the 20-day rule applies to inventory collateral. The PMSI position is established on the latter of these two dates: the UCC file date or date that the prior secured party was notified.
Lenders must carefully review their processes as the strict compliance requirements demand proper documentation. Even minor differences from the statutory rules could lower the secured party’s claim over other creditors.
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