Trade creditors often find themselves categorized as “general unsecured creditors” when a customer files for bankruptcy. However, some creditors benefit from liens that have been contractually negotiated or statutorily granted, potentially elevating the priority of their claims. To secure this priority, the lien must be properly granted and perfected under applicable law before the customer files for bankruptcy, and in a manner that does not expose the lien to avoidance as a “preferential transfer.”

Common trade creditor liens include consensual liens on specified assets, purchase money security interests (PMSI), consignment arrangements, mechanics’ liens, and shippers’ liens. For a lien to be treated as a secured claim in bankruptcy, it must be valid, properly perfected, and unavoidable. The validity and perfection of the secured claim are determined under state law, and these steps must be taken and maintained before the customer files for bankruptcy.

Under the Uniform Commercial Code (UCC), liens on most types of personal property are perfected by filing a properly completed financing statement with the appropriate recording office or by possession of the collateral. Common mistakes include improperly completed financing statements, filing in the wrong place, and failing to update or renew financing statements. Additionally, perfection may require other steps, such as recording a mortgage for real property liens or obtaining a deposit control agreement for bank accounts.

Creditors must carefully examine and confirm the documentation and perfection status of their secured claims. This should be done at the outset of a credit relationship and revisited if the customer shows signs of financial distress. Experienced counsel can assist in understanding and optimizing your secured position to avoid costly disappointments down the road. Read the full article here.