Searching for UCCs is only part of the picture. Should a creditor file bankruptcy, certain liabilities are paid before anyone else, including federal tax liens, state tax liens, and judgment liens. You may not receive even a partial payment if the debtor has too many liens depending on the circumstances. Thus, checking these priority liens before lending money or financing equipment is imperative.
The importance of a thorough lien search
Individuals or entities could have UCC, tax liens, and judgment liens on personal and real property. Searching only for UCC filings will not uncover all possible liens on record. Additionally, searching only in the state or county where the debtor is located is insufficient. Only searching UCC records will give you a false impression that the collateral is unencumbered. Federal tax liens, state tax liens, and judgment liens are not consensual, so the debtor may not even know about these liens.
A critical part of due diligence
Because liens usually have priority in bankruptcy – that is, they are paid first – your due diligence must be thorough. A professional company that searches for liens can make your lien search easier and ensure you find every lien on the debtor, including federal tax liens, state tax liens, and judgment liens.
Federal tax liens
The Internal Revenue Code and state laws determine where the Internal Revenue Service (IRS) files a federal tax lien. If the IRS doesn’t file the lien or files it in the wrong office, the federal tax lien will not have priority during bankruptcy. Additionally, different rules apply to real estate and personal property.
In most cases, the IRS will file the lien in the state where the corporation is registered to do business. Corporations can be registered to do business in more than one state. Liens could be filed in county courts, district courts, and county recorder’s offices.
A federal tax lien is a legal claim against a debtor’s property, and it attaches to every piece of real and personal property the debtor owns, including financial assets and accounts receivable.
If a debtor has a federal tax lien, you should not extend credit until the lien is cleared. Bankruptcy cannot clear a debtor’s lien unless paid in full. If the debtor does not pay the lien, the IRS can levy (take) the debtor’s property. You would not receive your money or the equipment.
State tax liens
States can also file liens against a debtor’s property. Each state has its taxation laws, and most require a public notice filed to document the state tax lien. While each state can choose the office where to file state tax liens, most generally file them with the county recorder or clerk of court. Some states may file tax liens with the Secretary of State’s office in addition to a local office.
Judgment liens
If a court orders a debtor to pay a fine, reimburse someone, or pay its bills, and the debtor ignores the order, the judgment or decree can become a judgment lien on the debtor’s real estate. Sometimes, a judgment can be against personal property, such as a vehicle, a business, or other personal property.
In many cases, a judgment lien is filed in the same office as tax liens – usually the clerk of the court’s office. The state may also require judgment liens to be filed with the county recorder’s office. Some states also have central and local filing of judgment liens.
Consequences of not performing an extensive lien search during due diligence
The value of an extensive lien search for businesses includes several factors, including:
- Locating undisclosed liabilities that may be significant obligations on the debtor, including unpaid taxes, mortgages, and other debts.
- Minimizing the risk of legal disputes with government entities and other creditors.
- Minimizing financial loss, including expenses to settle outstanding debts or legal fees. You could also lose your collateral if the government or courts place a levy on the collateral.
- Locating diminished property values caused by liens. If values are diminished, less money is available to pay you if the debtor has federal tax liens, state tax liens, or judgment liens.
- Locating canceled insurance policies if an insurance company canceled the policy due to liens.
- Minimizing the risk of using collateral with a clouded title.
- Reducing the risk of reputational damage with stakeholders, buyers or investors.
- Reducing the risk of non-compliance with regulatory or legal requirements due to a lien.
Federal tax liens, state tax liens, and judgment liens generally apply to the same type of property covered by UCC liens. However, a UCC lien is consensual, meaning the debtor signed a document agreeing to use the property as collateral. Federal, state, and judgment liens are not consensual – the government or court places a lien on property without the debtor’s permission.
Retaining a professional to conduct an extensive lien search
Searching for liens on your own means you will most likely miss some because businesses can be registered in more than one state or have offices in more than one county or state. Not all states require liens to be filed statewide – some are only in counties, which makes it easy to miss a lien.
A professional lien search company has the ability to create a comprehensive search in all states and counties for federal tax liens, state tax liens, judgment liens and UCC liens, which means you get all of the information required to make a sound decision on lending money and / or using real and personal property as collateral.
Sources
- https://www.irs.gov/businesses/small-businesses-self-employed/understanding-a-federal-tax-lien
- https://www.irs.gov/irm/part5/irm_05-017-002
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