Purchase Money Security Rules in Equipment and Inventory – Part One
Corporate, Due DiligenceWe are pleased to welcome attorney, Bennett L. Cohen of Cohen, Salk and Huvard, P.C., as a special guest blogger. Please read on for the first installment of Bennett’s seven-part blog series on Purchase Money Security Interest in Equipment and Inventory.
We are routinely fielding questions from loan officers about the mechanics of purchase money security interests in inventory and equipment. Lenders find themselves on both sides of the fence from time to time, being either: (i) the holder of a blanket security interest in the borrower’s assets facing a potential purchase money lender, or (ii) a lender being asked to finance specific items of inventory or equipment for a borrower who has previously granted a blanket security interest in all of its assets to a blanket lien lender.
The most common purchase money security interest transactions encountered are those involving equipment and inventory, and for this reason this article focuses on such collateral types. However, it should be pointed out that there are also purchase money rules under Revised Article 9 of the Uniform Commercial Code (the “Code”) governing chattel paper (which include equipment leases, installment sale agreements and certain notes and security agreements), fixtures and software.
First, it is important to distinguish between “equipment” and “inventory” under the Code since there is sometimes confusion regarding when items of equipment are classified as “inventory” under the Code (and such classification becomes important for determining which purchase-money rules apply, as well as for collateral description purposes). Under the Code “equipment” means goods, other than inventory, farm products or consumer goods, that are used in the borrower’s business (such as a printing press, computer system, machine tools, etc.). Under the Code “inventory” means goods held for sale or lease, or which are leased, by the borrower or are to be furnished under a contract of service. Thus, equipment owned by a leasing company held for sale or lease, or that is otherwise being leased by the leasing company, is classified as such leasing company’s “inventory” under the Code (even though it may commonly be referred to as equipment).
In this blog series, we will examine some frequently asked questions from loan officers and administrators about purchase money transactions.
Frequently Asked Question # 1: How is a “Purchase Money Security Interest” Created?
A purchase money security interest (a “PMSI”) can be created (a) if a lender advances funds to the borrower to buy purchase money collateral and obtains a security interest in such collateral, and otherwise qualifies for a PMSI under the Code as described below, or (b) in favor of a seller of purchase money collateral if the seller “retains” a security interest in such collateral to secure all or part of the price thereof, or (c) if a buyer signs an installment contract to finance the purchase of goods, the seller is granted a purchase money security interest (which can be assigned to a lender or other creditor who then is the holder of the PMSI).
Be sure to check back next week when Bennett L. Cohen answers more of your questions on PMSI! Looking for more educational resources? Visit the First Corporate Solutions resource library here to download documents relating to Corporate Transactions, UCC Filing, Lien Searching and more!