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Security Interests in Uncommon Collateral:

IP, Insurance Issues, Partnership Interests and More Navigating Attachment, Perfection and Priority Issues Under the UCC, Federal and State Law

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THURSDAY, FEBRUARY 14, 2013

Presenting a live 90-minute webinar with interactive Q&A

R. Andrew Richards, Partner, McCarter & English, New York

Janet M. Nadile, Counsel, Simpson Thacher & Bartlett, New York

Joseph K. Hegedus, Partner, Lewis Brisbois Bisgaard & Smith, Los Angeles

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Security Interests in Uncommon Collateral: Navigating Complex Issues of Attachment, Perfection and Priority Under the UCC and Applicable State and Federal Law

5

Live 90 Minute Teleconference Program with Interactive Q & A

Thursday, February 14, 2013

1:00 p.m. Eastern Time /12:00 p.m. Central Time /

11:00 a.m. Mountain Time / 10:00 a.m. Pacific Time

Sponsored by the Legal Publishing Group of Strafford Publications

Security Interests in Uncommon Collateral

Financing Intellectual Property: Intersection of UCC Article 9 and Federal Law – Janet M. Nadile, Simpson Thacher & Bartlett LLP

Aircraft, Marine Vessels and Other Transportation Assets – R. Andrew Richards, McCarter & English, LLP

Insurance – Joseph K. Hegedus, Lewis Brisbois Bisgaard & Smith LLP

LP and LLC Equity Interests and Investment Property Issues –

Janet M. Nadile, Simpson Thacher & Bartlett LLP

R. Andrew Richards, McCarter & English, LLP

6

Financing Intellectual Property: Intersection of UCC Article 9

and Federal Law

Janet M. Nadile

February 14, 2013 Strafford Webinar

Article 9 Issues: Scope

8

Article 9 is the law of secured transactions in personal property as adopted in each state.

9-109(a) sets forth the general scope of Article 9, which applies to, among other things:

“a transaction, regardless of its form, that creates a security interest in personal property . . .”

“a sale of accounts, chattel paper, payment intangibles, or promissory notes;”

9-109(c) : “This article does not apply to the extent that . . . a statute, regulation, or treaty of the United States preempts this article;”

Article 9 Issues: Enforceability

9

A security interest is enforceable against the debtor and third parties if it has attached and is perfected.

Attachment - 9-203

value has been given, the debtor has rights in the collateral or the power to transfer rights in the collateral to a secured party; and the debtor has authenticated a security agreement that provides a description of the collateral.

9-108 provides that the collateral must be reasonably identified. Examples: specific listing, a type of collateral defined in Article 9

No definition for any type of intellectual property in Article 9

9-102(a)(42) contains a catch all phrase “general intangibles”

9-102 (a) (44) defines “goods” to include software embedded in goods, otherwise, software independently is “general intangible.”

Article 9 Issues: Perfection

10

General rule in 9-310(a) states that “a financing statement must be filed to perfect all security interests . . . .”

9-301(a) provides that “ . . .the local law of [the debtor’s] jurisdiction governs perfection, the effect of perfection, and the priority of a security interest in collateral.”

9-307 (b) provides the general rules for the Debtor’s location; for an organization, its place of business or chief executive office.

9-307(c) contains an exception for debtors not located in a jurisdiction whose law provides for a filing system for nonpossessory security interests: the debtor is deemed located in the District of Columbia

9-307(e) contains an exception for “registered organizations.”

9-501(a)(2) designates the filing office in which to file the financing statement to perfect the security interest

Article 9 Issues: Perfection and Preemption

11

But there are always exceptions to the general rule.

9-310(b)(3) states that filing a financing statement is not necessary to perfect a security interest “in property subject to a statute, regulation, or treaty described in Section 9-311(a);”

9-311(a)(1) provides that the filing of a financing statement is not necessary or effective to perfect a security interest in property subject to, among other things, “a statute, regulation, or treaty of the United States whose requirements for a security interest’s obtaining priority over the rights of a lien creditor with respect to the property preempt Section 9-310(a);”

Article 9 Issues: Perfection and Preemption

12

Article 9 filing system governs perfection of security interests in personal property unless the federal trademark, patent or copyright statutes specifically mandate a national filing system for security interests in such property.

The relevant federal statutes – The Lanham Act, The Patent Act and The Copyright Act – are not entirely clear, so courts have addressed perfection of different types of intellectual property with varied results. The Supreme Court of the United States has never addressed this issue.

Article 9 Issues: Perfection of Security Interests in Trademarks

13

The Lanham Act, 15 U.S.C. 1060 “[a]n assignment [of a federally registered trademark] shall be void against any subsequent purchaser for a valuable consideration without notice, unless it is recorded in the Patent and Trademark Office within three months after the date thereof or prior to such subsequent purchase.”

Leading case: In reTR-3 Industries, Bankruptcy Court, CD CA, 1984

Issue: Did lender have a perfected security interest in the “TR-3” trademark on the basis of filing a UCC financing statement describing general intangibles, in the absence of also filing in the PTO?

Result: The Bankruptcy Court found that the Lanham Act contains no statutory provision for registration, recording or filing of any instrument or document asserting a security interest in trademarks. Thus, no federal preemption; the security interest was perfected by a properly filed UCC financing statement; goodwill was also covered by “general intangibles”.


14

Isn’t a security interest in a trademark an “assignment”?

In re Roman Cleanser, Co., Bankruptcy Ct, ED Mich, affd 6th Cir.

Issue: Does lender’s UCC financing statement describing trademark collateral as “general intangibles” perfect the security interest in a federally registered trademark or are security interests in such collateral governed by the Lanham Act’s registration system?

Result: The court held that Lanham Act does not contemplate registration of collateral assignments of trademarks, only outright assignments. The UCC financing statement perfected the security interest.

TriMarchi vs. Together Development Corp., D. Mass

Issue: Does secured party’s PTO filing describing the trademark and goodwill of the business connected with the mark perfect the security interest (described as an “assignment” in the loan documents)?

Result: Lanham Act doesn’t provide registration for security interests, only for outright assignments; the collateral was unperfected.


15

The Lanham Act does not contain any provision regarding perfection of a security interest in property subject to it, so there are no federal perfection steps that preempt application of Article 9.

Recommendation: File UCC financing statement to perfect security interest in trademarks (cannot transfer trademark without attendant goodwill). Filing at the PTO in addition to, not instead of, may obviate litigation.

Article 9 Issues: Perfection of Security Interests in Patents

16

Patent Act 35 U.S.C. 261

“An assignment, grant or conveyance shall be void as against any subsequent purchaser and mortgagee for a valuable consideration without notice, unless it is recorded in the Patent and Trademark Office within three months from its date or prior to the date of such subsequent purchase or mortgage.”

Leading case: In re Transportation Design & Technology, Inc., Bankr. Ct., SD CA

Issue: Does a UCC financing statement alone, describing the collateral as “all general intangibles now owned or hereafter acquired,” perfect a security interest in patents?

Result: The security interest was perfected. A federal filing is required if the competing party is an outright “purchaser” or “mortgagee,” but not when the competing party was a bankruptcy trustee (lien creditor). The UCC governs other matters not covered by federal law, such as foreclosure.


17

Isn’t a security interest in a patent considered an assignment?

9th Circuit decided Cybernetic Services Inc. in 2001 Issue: Did a UCC financing statement, describing the collateral as general intangibles, perfect the security interest in the patent?

Result: “Assignment” in the Patent Act means a transfer of full legal title. An Article 9 security interest is not an “assignment, grant or conveyance” for purposes of federal law. The UCC financing statement was enough to perfect the security interest. (Did not address sufficiency of federal filing.)

10th Circuit decided In re Tower Tech, Inc. in 2003

Issue: Does a filing with the PTO, without filing a UCC financing statement, perfect a security interest in patents?

Result: Federal filing alone does not perfect the security interest.

Massachusetts Bankruptcy Court decided In re Coldwave Systems in 2007

Issue: Does PTO filing made 2 years before bankruptcy filing perfect security interest in patent where UCC filing covering patent was filed 89 days before bankruptcy?

Result: No, state filing fell within preference period, could be avoided, and the PTO filing alone left the secured party unperfected.


18

The Patent Act defines “assignment” in a way that does not include security interests, so there are no federal perfection provisions that preempt application of Article 9. However, “assignment” does relate to subsequent purchasers and mortgagees.

Recommendation: File UCC financing statement to perfect. Filing at the PTO in addition to, not instead of, will also protect the secured party against subsequent purchasers and mortgagees.

Article 9 Issues: Perfection of Security Interests in Copyrights

19

Copyright Act 17 U.S.C. 205(a)

“Any transfer of copyright ownership or other document pertaining to a copyright may be recorded in the US Copyright Office.”

“Transfer” is defined to include “mortgage” or “hypothecation” as well as “exclusive license.” 17 U.S.C. 101

Leading Case: In re Peregrine, CD CA

Issue: Does UCC financing statement covering all inventory consisting of films, and all accounts, contract rights, chattel paper, general intangibles, instruments, equipment, and documents related to such inventory, perfect the security interest absent a filing at the Copyright Office?

Result: Court found implicit federal preemption as a matter of public policy. Filing at the Copyright Office is necessary to perfect copyrights and related accounts receivable.


20


21

Bankruptcy Court in Arizona went further in In re Avalon Software

Issue: Does UCC filing covering accounts, general intangibles, equipment, inventory and proceeds, now owned and hereafter acquired perfect a security interest in copyrighted software and proceeds, as well as non-copyrighted software and derivatives?

Result: Filing in the Copyright Office is necessary; unregistered copyrights must be registered and then filed against in the federal office since the UCC is preempted and a UCC financing statement does not perfect.

9th Circuit addresses the issue again in In re Auxiliary Power Co.

Issue: Does UCC describing general intangibles and unpublished copyrights perfect the security interest in unregistered copyrights or does federal law govern perfection of security interests in unregistered copyrights?

Result: Federal statute does not have a comprehensive scheme for unregistered copyrights, so it does not preempt. UCC financing statement alone will perfect.


22

The Copyright Act implicitly preempts application of Article 9, because it defines a “transfer” to include security interest in copyrights (and also exclusive inbound copyright licenses). Thus, perfection on such is achieved only through federal filing at Copyright Office. However, unregistered copyrights are not subject to the Copyright Act, so Article 9 applies, and perfection must be obtained through UCC filing.

Recommendation: File at the Copyright Office to perfect security interest in copyrights and exclusive inbound copyright licenses. File UCC financing statement to perfect security interest in unregistered copyrights.

Article 9 Issues: Summary of Perfection Rules

23

T y p e o f I n te lle ctu a l P r o p e r ty

U C C F in a n c in g S ta te m e n t

P a te n t a n d Tr a d e m a r k O fficeF ilin g

C o p y r ig h t O ffic e F ilin g

Tra d e m a rk R e q u ire d P e rm is s iv e n / a

P a te n t R e q u ire dP e rm is s iv e(R e q u ire d a g a in s t p u rch a s e rs a n d s u b s e q u e n t m o rtg a g e e s )

n / a

R e g is te re dC o p y rig h t

P e rm is s iv e n / a R e q u ire d

U n re g is te re d C o p y rig h t

R e q u ire d n / a n / a

Article 9 Issues: Licensor as Grantor

24

Licensor’s transfer of its rights to payment under the license comes within scope of Article 9: Article 9 has broadened definition of “accounts” to apply to payment obligations arising out of sale, lease, or license of both tangible and intangible property (this now includes licensees’ payments for use of software). 9-109(3) Licensor can grant security interest in its right to payment arising out of license of software, even if the underlying contract, or other law, restricts the licensor’s right to grant such security interest. 9-406(d)

Article 9 Issues: Licensee as Grantor

25

Licensee’s ability to grant security interest in its rights under a license:

Licensee can only grant security interest in its own rights in the collateral (it cannot grant a security interest in the licensor’s property). 9-203

Licensee can grant such security interest even if there is a restriction on such transfer in the contract, to the extent such restriction would interfere with the creation, attachment or perfection of the security interest. 9-408(a)

However, any such restriction in the contract is enforceable against the secured party if it should attempt to enforce its security interest in the license. 9-408(c)

Value of this type of collateral: Licensees can use otherwise non-assignable rights under a license as collateral to obtain financing—licensee’s rights reduced to cash will provide value to the secured party. 9-408(c) protects the licensor from concerns that a foreclosing secured party can step into the shoes of the licensee without the licensor’s consent.

Article 9 Issues: Licensees in the Ordinary Course of Business

26

“A licensee in the ordinary course of business takes its rights under a nonexclusive license free of a security interest in the general intangible created by the licensor, even if the security interest is perfected and the licensee knows of its existence.” 9-321(b)

This provision is designed to address rights between the secured party and its borrower’s licensee. Article 9 balances the interests of the secured party who wants recourse to its collateral (rights of its borrower as licensor) and the borrower’s ordinary course of business licensee’s rights in the license. Article 9 reflects the policy decision that so long as a customer is a direct customer of the borrower, Article 9 will protect it from borrower’s secured party’s security interest. Likewise, the secured party is protected from downstream sublicensors . Secured parties will only be affected by risk of its own borrower’s activities, not the activities of remote parties it cannot monitor.

Intellectual Property: Case law citations

27

• TR-3 Industries, 41 BR 128, 39 UCC Rep 279 (Bankr. CD Cal. 1984)

• In re Roman Cleanser Co., 43 BR 940, 39 UCC Rep. 1770 (Bankr. ED Mich. 1984), aff’d, 802 F2d 207 (6th Cir. 1986)

• TriMarchi v. Together Development Corp., 43 UCC Rep.2d 13, 255 BR 606 (D. Mass. 2000)

• In re Transportation Design & Technology, Inc., 48 BR 635, 40 UCC Rep 1393 (Bankr. SD CA 1985)

• Cybernetic Services, Inc., 239 BR 917 (Bankr. 9th Cir 1999), aff’d, 252 F3d 1039, 44 UCC Rep2d 639 (9th Cir 2001), cert. denied, 534 US 1130 (2002)

• In re Tower Tech, Inc., 50 UCC Rep2d 923, 2003 WL21300345 (10th Cir. 2003)

• In re Coldwave Systems, LLC, 368 BR 91 (Bankr. D. Mass. 2007)

• In re Peregrine Entertainment Ltd., 116 BR 194, 11 UCC Rep2d 1025 (CD CA 1990)

• In re Avalon Software, Inc., 209 BR 517, 33 UCC Rep2d 650 (D. Ariz. 1997)

• In re Auxiliary Power Co., 303 F3d 1120, 48 UCC Rep2d 447 (9th Cir 2002)

Uncommon Collateral: Aircraft, Marine Vessels and other Transportation

Assets

R. Andrew Richards February 14, 2013

AIRCRAFT COLLATERAL

29

Aircraft Lien Terminology

Federal Aviation Administration Authorization Act, 49 USCA §§44101

Federal Aviation Administrator

Aircraft Registration Branch

Civil Aviation Registry

Aircraft Registration Application, AC Form 8050-1

N-number

Certificate of Aircraft Registration, AC Form 8050-3

Aircraft Bill of Sale

Geneva Convention on the Recognition of Rights in Aircraft

Convention on International Interests in Mobile Equipment

Protocol on Matters Specific to Aircraft Equipment

Contracting State

United States Entry Point to the International Registry

International Interest

Aircraft Object

Prospective International Interest

FAA Entry Point Filing Form International Registry, AC Form 135

Transaction User Entity

Professional User Entity

30

Applicable Law with respect to Aircraft Collateral

UCC: Article 9 of Uniform Commercial Code

Governs all elements of security interest in aircraft other than perfection –

creation, attachment, priority & enforcement

Since FAAA maintains registry for recording security interests, perfection

under UCC is preempted pursuant to:

• Section 9-109(c), which provides that UCC does not apply to the

extent that statute, regulation, or treaty of the U.S. preempts it, and

• Section 9-311(a)(1), which provides that filing of financing statement is

not effective to perfect security interest in property subject to statute,

regulation or treaty of U.S. whose requirements for a security

interest’s obtaining priority over rights of lien creditor with respect to

the property preempt requirement to perfect by filing of financing

statement.

UCC applicable to any collateral not covered by FAAA, including as to

perfection (e.g., spare parts owned by non-carrier, ancillary rights, etc.).

31


FAAA: Federal Aviation Administration Authorization Act

Policy behind creation of national registry: aircraft are

highly mobile collateral.

In respect of security interests, governs only perfection

– how to perfect & effect of failure to perfect with

respect to other creditors.

Not a title recording system; therefore doesn’t provide

evidence of ownership. FAAA §44103(c). Just a

registry for notice of interests & liens.

Recording & relevant registration provisions at 49 USCA

§§44101, et seq., & 14 CFR, Parts 45, 47 & 49.

32


Cape Town Convention: Convention on International

Interests in Mobile Equipment, as supplemented by

Protocol on Matters Specific to Aircraft Equipment

Both documents are read together as single document,

governing among other things perfection and

enforcement of liens. Remedies similar to UCC.

Based in Dublin, Ireland, with 55 ratifying countries.

Accessed in US through FAA.

Provides secured party with new remedy: de-registration

& export. Authorization from debtor should be filed with

registration of security interest.

33

Geneva Convention on the Recognition of Rights in Aircraft

Signatory countries agree to enforce liens created in

other signatory countries. Superseded where both

countries have ratified Cape Town Convention.


34

Gaps in scope of covered collateral between statutory schemes

FAAA: covers (i) Aircraft; (ii) specifically identified engines

(550 hp) & propellers (750 hp); and (iii) air carrier engines,

propellers, appliances & spare parts. FAAA §44107.

Cape Town Convention: covers “aircraft objects”, comprised of

(i) airframes (certified to transport 8 persons or 2750 kg of

goods) & attached accessories, parts & equipment; (ii)

helicopters; and (iii) aircraft engines (1750 lbs of thrust or 550

take-off hp). Protocol, Art. I. Spare parts & propellers not

physically attached to aircraft not covered

Therefore, need to comply with each of FAAA, Cape Town

Convention & UCC because of limitations & gaps in scope.


35

Prerequisite for Filing under FAA

Civilian aircraft must be registered with FAA in order to be operated &

for security interest to be recorded against them.

Scope of permitted aircraft filings

Aircraft Registry available for:

• Aircraft not registered under laws of foreign country, and

• that are owned by (i) US citizen; (ii) resident alien; (iii) non-citizen

corporation organized under laws of a US state and such aircraft

based & primarily used in US. FAAA §44102.

Citizen under FAAA is (i) individual US citizen; or (ii) corporation

whose president, managing officers & 2/3 of Board are US citizens &

75% of voting interest is owned or controlled by US citizens. FAAA

§40102.

Registration must be in the name of legal owner.

36


Registration of Aircraft

Civil Aviation Registry (the “Aircraft Registry”) maintained by

Aircraft Registration Branch of FAA, located in Oklahoma City

To register, submit the following to Aircraft Registry: • Aircraft Registration Application, AC Form 8050-1 (original

only – no downloads);

• Proof of ownership (usually bill of sale), including chain of

title, if necessary; and

• $5 registration fee.

FAA then delivers Certificate of Aircraft Registration, AC

Form 8050-3.

37


Lien Searches & Due Diligence

Conducted by searching the aircraft (using N-number, serial

number, etc.) rather than by debtor’s name. Search agents

listed on FAA website.

Purpose: verify chain of title; liens.

Concerns: does not establish ownership & may not be current

as a result of recording delays or failure of prior owners to

properly document title. So comprehensive due diligence

required.

Verify chain of title through title documents; conduct UCC lien

searches.

Filings on Aircraft Registry & International Registry do not

lapse, as UCC financing statement does after 5 years.

38

Manner of Filing

Under FAAA:

Submit Conveyance Recordation Notice, AC Form 8050-41, to Aircraft Registry.

Execution formalities – in ink, with typed names & signatory titles.

Secured party doesn’t need to be citizen, but non-citizens face issues upon foreclosure.

Chain of title must be correct & of record. If debtor is not registered owner, it must register & submit necessary documents in chain of title upon filing of security agreement.

After filing, Aircraft Registry Conveyance Recordation Notice, AC Form 8050-41, is returned to secured party with filing information. To release lien later, secured party may sign release portion & re-file.

39

Manner of Filing

Under Cape Town Convention:

Under Cape Town Convention, FAA Aircraft Registration

Branch in Oklahoma is designated Entry Point to

International Registry.

To register, secured party submits FAA Entry Point

Filing Form International Registry, AC Form 135. FAA

then stamps authorization code on it & returns it to

secured party. Secured party uses code to

automatically register online. Debtor must consent to

registration.

Similar to UCC, Cape Town Convention permits filing of

“notice of prospective interest” that is valid for 60 days.

40

Elements of a Security Agreement

Mandatory provisions

Names of parties

Express words of grant of security interest in collateral

Identify collateral. For aircraft: by manufacturer name,

model designation, serial number & N-number; for

engines/propellers: by manufacturer name, model

designation & serial number; for spare parts: general

description & location.

Sign in ink by debtor; secured party doesn’t need to

sign & doesn’t need to be citizen.

Pay recording fee.

41


Customary and Recommended Additional Provisions

Representations as to:

size & capacity of aircraft to establish applicability of

statutory scheme

citizenship of debtor

location of debtor in Cape Town Convention “contracting

state”

authorization of filings & registration

42


Covenants as to:

Adherence to three-year registration renewal cycle

Territorial restrictions – continental US or limited to

countries of low risk of loss or parties to Geneva/Cape

Town Conventions to facilitate enforcement of remedies

Maintenance – in accordance with FAA requirements,

manual, manufacturer’s bulletins; replacement of parts;

proper inspections; notation in log

43


Requirement for funding of maintenance reserve –

common practice

Replacement parts under engine interchange and

pooling agreements to be subject to security interest

Appropriate levels of insurance coverage

Affixing plaques to airframe and engines giving notice of

liens.

44

Priority Issues

Effectiveness of security interest

FAAA:

• Perfection by recording on the Aircraft Registry - filing

of financing statement will be ineffective for assets

covered by FAAA.

• Prior to registration of a security interest on Aircraft

Registry, only effective against debtor & third parties

having actual notice of security interest. FAAA

§44108. Practice tip: plaque giving notice of security

interest should be affixed to aircraft.

• Filing date is the date and time it is received by FAA.

45

Priority Issues

• Security interest becomes effective against third parties upon filing, even though public recording by FAA may not happen until later. Buyer in ordinary course of business without knowledge of security interest takes title free of it.

• Split in authority related to statutory lienholders (mechanics’ liens), but majority view is that UCC governs & they have priority under Section 9-333 over security interests recorded on Aircraft Registry.

• Assignments of leases may be recorded on Aircraft Registry. Under case law, it is not clear if that perfects collateral assignments of rights. A financing statement should be filed as well.

46

Priority Issues

Cape Town Convention

First to file rule, measured from time of registration of

security interest (or its prefiling) on International

Registry.

Upon filing on International Registry, there is priority

over other filings on International Registry and security

interests not registered there. Filings on International

Registry have priority over filings on Aircraft Registry.

Actual knowledge of other security interests is not

relevant.

47

Conclusion regarding perfection:

perfect under each of the three

statutory schemes to cover interstitial

collateral or collateral shifting from

federal to state coverage (e.g., aircraft

that is de-registered and cannibalized

for spare parts shifts from FAAA to

UCC perfection).

48

MARINE VESSEL COLLATERAL

49

Applicable Law for Marine Vessel Collateral

Article 9 of Uniform Commercial Code

As with aircraft, Article 9 governs creation, attachment &

validity of security interest in most vessels. But in addition to

perfection, federal law addresses priority & certain remedies.

U.S. Coast Guard maintains title registry at National Vessel

Documentation Center (“NVDC”) in West Virginia for recording

security interests. Therefore, perfection under UCC is again

preempted pursuant to Section 9-109(c).

Federal statutes cover only certain specified collateral.

Substantial amount of collateral assets typically associated

with vessel ownership & operation remains subject to Art. 9.

50


Federal Statutes: Chapter 313 of Title 46 (recodifying at 46 USC

§§31301 – 31330 the Ship Mortgage Act) and Documentation of

Vessels Act (46 USC §§12101 et seq.)

Relevant statutes provide for creation of security interest in

vessel by execution of ship mortgage. Secured party will want

ship mortgage to have “preferred” status for statutory benefit.

Federal statutes go beyond governing perfection, determining

priority of preferred ship mortgage with respect to other

claimants & lienholders & provide favorable remedies.

Ship registration & relevant recording provisions at 46 CFR

Part 67, Subparts O, P & Q.

State Certificate of Title statutes for smaller/recreational vessels

51


Limited scope of collateral covered by federal law requires

multiple perfection methods

Federal law related to ship mortgages is limited, covering only

liens on a vessel itself of a size over 5 net tons.

“Vessel” is construed broadly and includes:

• every description of watercraft capable of being used as a

means of transportation on water (1 USC §3), and

• vessel components on board (e.g., anchors & engines).

Doesn’t include removable materials/items stored on land.

If otherwise meeting standards for documentation with Coast

Guard, lien on such a vessel can be perfected through

preferred ship mortgage.

52


Where a ship mortgage cannot be filed with NVDC (e.g.,

because of foreign registry), the ship mortgage is still capable

of perfection and enforcement under Article 9.

To perfect when ship mortgage cannot be filed with NVDC, &

with respect to collateral not comprising the “vessel”, financing

statement must be filed at debtor’s location.

Certain vessels may be documented under state law through

certificate of title statutes (e.g., vessels under five tons, ship’s

dinghy, recreational boats) & are not eligible for

documentation through Coast Guard.

These are perfected under state certificate of title statutes by

notating lien on certificate of title. In New York, this is done at

DMV. See applicable state statutes.

53


Related assets not comprising “vessel collateral” perfected under federal law:

• Earnings from charters – Secure by assignment, and – Perfect by filing financing statement, since “Account”, as

defined at UCC Section 9-102(a)(2), is “a right to payment of a monetary obligation, whether or not earned by performance . . . (vi) for the use or hire of a vessel under a charter or other contract . . .”

• Requisition proceeds – government payments for use of vessel in time of emergency/war; secure by assignment

In summary: multiple methods of perfection may be required in a single transaction, by filing a preferred ship mortgage, filing financing statement & notating lien on certificate of title.

54

Documentation Req’s for Preferred Ship Mortgage

For a secured party to file ship mortgage with NVDC, vessel

to be encumbered must either:

• have Certificate of Documentation as a U.S. flag vessel, or

• be the subject of application for documentation, filed with

NVDC in substantial compliance with relevant regulations.

Documentation of a vessel with NVDC:

• May be obtained at election of owner if vessel is at least

five tons,

• Must be obtained if vessel is at least five tons & engages

in fishing or coastwise trade, and

• Is exempt for vessels under five tons or non-self-propelled

& engaged in coastwise trade.

55


A Certificate of Documentation will only be issued to U.S.

citizen. Citizenship is documented on Form CG-1258.

U.S. citizen includes: individual citizen, or corporation

incorporated under state law, whose chief executive

officer, board chair & minimum number of directors

constituting quorum are all U.S. citizens.

At the same time, proof of ownership must be

established: • For a new vessel, by submission of a Builder’s Certification

on Form CG-1261, or

• For a previously owned acquired vessel, by establishing

chain of title through bills of sale & other documents.

56


Requirements for documentation of preferred ship mortgage with NVDC:

The ship mortgage must: • include the whole vessel (no partial interests may be

mortgaged); • identify the vessel and the parties by name and address; • state amount of all obligations secured, direct and contingent; • state interest of the mortgagor in vessel; and • cover documented vessel or vessel with pending application

for documentation in substantial compliance with law. 46 USC §31321-22.

Generally, no U.S. citizenship requirement for mortgagee (other than in case of certain fishing vessels). Upon foreclosure, foreign mortgagee not eligible to own documented vessel cannot operate the vessel & would need to hold it for resale.

57


If ship mortgage filed together with Optional Application for

Filing, Form CG-5542, and that informational form has been

properly completed, NVCD will accept the ship mortgage for

filing without further review.

Perfection occurs at time of filing. 46 USC §31321.

If Coast Guard rejects filing, it gives notice to mortgagor and

mortgagee; if filing not corrected within 90 days, filing will be

terminated. Secured party should hold power of attorney to

cure defects in mortgage.

Copy of recorded mortgage must be maintained on vessel, for

review by any vendor of supplies whose sales could give rise to

maritime lien. 46 USC §31324.

58

Due Diligence

NVDC is notice registry that doesn’t establish title, so

comprehensive due diligence required. Verify chain of title

through title documents. Not all maritime liens required to be

recorded. Maritime liens are in rem, enforceable against

vessel itself. Coast Guard records liens against vessel, but

many are statutory & enforceable without public notice & may

have priority over ship mortgage.

Order Abstract of Title through NVDC to obtain all bills of sale,

ship mortgages & liens encumbering vessel.

Important to order lien/judgment searches against debtor -

many items of collateral may remain subject to state law.

Review state certificate of title records where applicable.

59

Recommended elements of a Preferred Ship Mortgage

Representations as to U.S. citizenship, ownership and

filed & unfiled liens existing prior to mortgage.

Covenants as to:

• Adherence to annual renewal filings,

• Appropriate levels & kinds of marine insurance

coverage.

Subsequent Advances provision – to operate the vessel

and move it to appropriate port if funding shortfall during

voyage.

60

Priority Issues

Effectiveness of security interest

Perfection of security interest in vessel by filing with

NVDC - filing of financing statement will be ineffective for

documented vessel.

Prior to filing a ship mortgage with NVDC, it is only

effective against debtor & third parties having actual

notice of the security interest.

Filing date is the date & time received by NVDC.

61

Priority Issues

Preferred Ship Mortgage has priority over all other liens,

other than:

• Preferred maritime liens, and

• Expenses, fees and costs assesses by federal court.

Preferred maritime liens are comprised of the following

liens:

• arising prior to the filing of the preferred ship mortgage,

• arising out of tort (i.e., liabilities under Oil Pollution Act of

1990),

• for wages of stevedores and crew,

• under the doctrine of general average, and

• for salvage. 46 USC §31301.

62

Benefits of documenting a preferred ship mortgage:

• Maritime lien status has priority over non-maritime liens.

• Debtor must obtain secured party’s consent before Coast

Guard will effect changes to vessel documentation, such

as ownership or home port.

• In rem admiralty action, against vessel itself in federal

district court.

• Upon judicial foreclosure proceeding, all other liens on

vessel are terminated and it may be sold free & clear.

• Additional remedies such as arrest of vehicle without

obtaining judgment.

• Documentation with NVDC does not lapse like a UCC

financing statement does after 5 years.

63

LEWIS BRISBOIS BISGAARD & SMITH LLP

SECURITY INTERESTS IN UNCOMMON COLLATERAL:

INSURANCE ASPECTS

Stafford Webinar - February 14, 2013

Joseph K. Hegedus

Lewis Brisbois Bisgaard & Smith LLP


SECURITY INTERESTS IN UNCOMMON COLLATERAL:

INSURANCE ASPECTS INTRODUCTION AND SCOPE OF PRESENTATION • Insurance documents and transactions. • Assignment of life insurance policy as collateral. • Types of insurance available to a lender to protect its interests. • Alternatives and unusual risks. • Other means to transfer risk.

65


INSURANCE DOCUMENTS AND TRANSACTIONS: General Observations

• Distinguish the insurance policy (and other insurance documents) from the substantive agreement (such as a security agreement) that requires a borrower to (a) purchase insurance, or (b) as discussed later, the requirement in that contract that the insurance policy name the lender as a loss payee or additional insured.

• The emphasis here is on what remedies the lender has to ensure that its collateral is insured, or that the lender’s interests are protected by some insurance mechanism.

66


INSURANCE DOCUMENTS AND TRANSACTIONS: Summary of Topics

• Certificate of insurance: What it is, what it is not, and what it may be. • Notice of cancellation or non-renewal to the lender. • Loss payee endorsement: Insurance coverage for the lender. • Intentional act exclusion. • Force-place coverage. • Lender’s vigilance after the security agreement or other contract is signed. • Insured-borrower’s fraud on the application. • Transfer of one corporation’s insurance policies to a purchaser. • Insurance in bankruptcy. • Insurer’s insolvency.

67


CERTIFICATE OF INSURANCE

• As a general proposition, a certificate of insurance is a document that confirms terms of coverage, usually stating the insurer, the insured, dates of coverage, types of coverage, and applicable limits.

• Strictly speaking, a true certificate of insurance is not a contract of

insurance. • Who has the legal right to issue a certificate? • It is not unusual that a piece of paper labeled, “certificate of

insurance,” is more than that. It can be a document that is intended to create coverage or extend coverage to additional property or to an additional insured. Thus, it can be a contract of insurance or an endorsement (amendment) of such a contract.

68


NOTICE OF CANCELLATION OR NON-RENEWAL TO LENDER

• By the loan agreement, have the borrower-insured obtain an endorsement (amendment) to the insurance policy to include a provision requiring the insurer to give advance written notice to the lender of cancellation or non-renewal.

• With notice, lender has the opportunity to act. • The insurer must follow literal requirements in giving

notice. • Lack of compliance may keep the insurance policy in effect

– even without payment of premium.

69


LOSS PAYEE ENDORSEMENT

• This is a common provision in property insurance policies: “The policy shall include a loss payee endorsement that provides coverage to any lending institution as its interest may appear.”

• Caution: Once the debt is extinguished through either payment or foreclosure, the mortgagee has no remaining interest in the insurance. In that connection, many unwary mortgagees have unwittingly extinguished their insurable interests when foreclosing on properties after losses occur.

• Add language to avoid this problem: “The Loss Payee has the right to receive loss payment even if the Loss Payee has started foreclosure or similar action on the Covered Property.”

• Add language that states the lender’s interest is not affected by the insured borrower’s misconduct.

70


INTENTIONAL ACT EXCLUSION

• Insurance does not cover one’s specifically intended acts.

• The exclusion is both set forth in the insurance policy and in most states implied by law.

• The trend of the law is not to apply the exclusion to the innocent insured.

71


FORCE-PLACE COVERAGE • In the loan agreement, add a provision to give the lender the right (but not

the obligation) to force-place coverage to protect the collateral and the lender’s interests if the insured-borrower fails to procure or maintain insurance coverage.

• Requirement for borrower to obtain and maintain insurance coverage: “Borrower shall keep the improvements now existing or hereafter erected on the Property insured against loss by fire . . . and any other hazards including, but not limited to, earthquakes and floods, for which the Lender requires insurance. This insurance shall be maintained in the amounts (including deductible levels) and for the periods that Lender requires. What Lender requires pursuant to the preceding sentences can change during the term of the Loan.”

• Provision allowing lender to force-place coverage: “If Borrower fails to maintain any of the coverages described above, Lender may obtain insurance coverage, at Lender’s option and Borrower’s expense. Lender is under no obligation to purchase any particular type or amount of coverage. Therefore, such coverage shall cover Lender, but might or might not protect

72


FORCE-PLACE COVERAGE (cont.)

Borrower, Borrower's equity in the Property, or the contents of the Property, against any risk, hazard, or liability and might provide greater or lesser coverage than was previously in effect. Borrower acknowledges that the cost of the Insurance coverage so obtained might significantly exceed the cost of insurance that Borrower could have obtained.”

• Under forced-place language, can a lender purchase insurance in an amount that exceeds the value of the collateral or the unpaid principal of the loan?

• Does federal law preempt state tort and contract law on force-place insurance when the lender is a federal bank or other federally chartered institution?

• The amount the lender charges the borrower for force-place coverage should be reasonable. Otherwise, the lender may be exposed to litigation for unfair business practices, and such litigation is often brought as a class action.

Borrower, Borrower's equity in

73


LENDER’S VIGILANCE AFTER THE SECURITY AGREEMENT IS SIGNED

74


INSURED-BORROWER’S FRAUD ON THE APPLICATION

75


TRANSFER OF ONE CORPORATION’S INSURANCE POLICIES TO A PURCHASER

76


INSURANCE IN BANKRUPTCY

• Insurance is treated as an asset of the debtor’s estate.

• Automatic stay applies.

• Bankruptcy court is likely to lift the stay to allow creditor to pursue the insurance policy only.

77


ASSIGNMENT OF LIFE INSURANCE POLICY AS COLLATERAL

• General principles relating to assignments under insurance policies

• Who is the typical borrower that may use a life insurance policy as collateral?

• Points to consider in having a life insurance policy as collateral: Check the language of the policy.

• Key features of a “collateral security agreement” on a life insurance policy

• Parties to the transaction

• Advantages and disadvantages to the borrower-insured

• Insurance policies other than life insurance policies as collateral

• “Stranger-owned life insurance” (STOLI) or “dead peasant insurance”

78


TYPES OF INSURANCE AVAILABLE TO PROTECT THE LENDER’S INTERESTS

• Collateral protection insurance • Credit insurance • Financial guaranty insurance • Key-employee insurance • Business interruption insurance • Contractual liability insurance • Surety or performance bonds • Professional liability and employment practices liability

insurance • Workers’ compensation insurance • Specialized coverage for crops, hail, livestock, aircraft,

watercraft, and others 79


ALTERNATIVES AND UNUSUAL RISKS

• Insurance relating to litigation over representations and warranties in sales and purchases of businesses

• Litigation buyout insurance

• Tax liability insurance

• Commercial general liability (“CGL”) insurance

• Insurance of computer data and systems

80


OTHER MEANS TO TRANSFER RISK

• Form or acquire an insurance company

• Form a captive insurer

81

Uncommon Collateral

LP / LLC Equity Interests and

Investment Property Issues



February 14, 2013

Securing LP and LLC Equity Interests

83

Overview

−Issues

• Shifting collateral classifications with different perfection and priority rules

• Interplay between UCC Articles 8 & 9

−Results of Inattention

• loss of priority

• loss of security interest altogether

Article 9 Classification

84

• For a security interest to attach and be enforceable, collateral generally must be described in a security agreement 9-203

• Article 9 classifications under 9-102

• Type of asset classification governs means of perfection and determination of priority

• Asset classification may shift over term of loan

Interplay of Article 9 Classification with Article 8

85

• Investment Property includes:

−security

−security entitlement

−securities account

−commodity contract

−commodity account 9-102(a)(49)

• “Security” is defined in 8-102(a)(15) and can be either certificated or uncertificated

Interplay of Article 9 Asset Classification and Article 8

86

• Corporate stock is straightforward

−“A share or similar equity interest issued by a corporation, business trust, joint stock company, or similar entity is a security.” 8-103(a)

• What about LP/LLC equity interests?

−“An interest in a partnership or limited liability company is not a security unless it is dealt in or traded on securities exchanges or in securities markets, its terms expressly provide that it is a security governed by this Article, or it is an investment company security. However, an interest in a partnership or limited liability company is a financial asset if it is held in a securities account.” 8-103(c)

• If not a security, then the LP/LLC interests are “general intangibles

Opt in to Article 8

87

• Must affirmatively elect to be covered by Article 8 to be treated as a security

• Silence, or affirmative election not to be covered, means the interests are “general intangibles”

• Certificate does not create a security; there must be affirmative “opt-in”

• Election to “opt-in” does not create a security under federal securities laws.

• Note: Crediting LP/LLC interests to a securities account will classify the collateral as investment property

Methods of Perfection and Consequences

88

• Excluding automatic perfection, there are 3 methods of perfecting a security interest under Article 9 −Filing of financing statement

−Possession

−Control

• General intangibles can only be perfected by filing (9-310) . First to file will have priority (9-322).

• Investment property can be perfected by any of the 3 methods (9-312(a), 9-313(a) and 9-314(c)).

• Conflict: when competing secured parties have perfected liens in the same collateral −possession prevails over filing (even if filing is earlier and secured party

knows of earlier filing)

−control prevails over both possession and filing

Methods of Perfection : Control for Investment Property (9-106/8-106)

89

• Control of Certificated Security in registered form:

−delivered to secured party and certificate indorsed to secured party or in blank form, or

−certificate registered in the name of secured party

• Control of Uncertificated Security

−uncertificated security is delivered to the secured party, or

−issuer has agreed it will comply with instructions originated by secured party without further consent by registered owner.

Benefits of Article 8 Opt In

90

• Initial “opt-in” to Article 8 insures priority if collateral is perfected by possession or control. General intangibles can only be perfected by filing.

• Possession/control protects against inadvertent loss of perfection due to failure to continue financing statement

• Article 8 classification gives secured party potential benefit as protected purchaser

Anti-Assignment Issues (continue)

91

• 9-406 provides that any prohibition or restriction on assignment/granting of security interest in general intangibles is ineffective to extent such creation/attachment/perfection of security interest gives rise to default, breach or termination right under the agreement

−Policy issue to facilitate financing

−Only negates agreement between debtor and issuer; while security agreement will be effective, secured party may not be able to enforce it against the issuer

Anti-Assignment Issues

92

• 9-406 negation of anti-assignment clauses only applies to general intangibles, this benefit is not available to secured party if there is an Article 8 opt-in to treat the collateral as investment property.

• State law considerations– DE’s 9-406 negation of anti-assignment clauses does not apply to LP/LLC interests; NJ follows Official Text.

−Important to review state law

−In DE, no negation of anti-assignment clauses, irrespective of classification as investment property or general intangible.

Practical Considerations

93

• Thorough due diligence review of LP/LLC agreement is critical

−How is equity interest classified at the outset?

−If anti-assignment clause in agreement, it may be critical to get written consent of the issuer

• Company counsel should consider opting in to Article 8 at formation, so this isn’t an issue in subsequent financings. Opt in can be conditional, upon financing/authorization of the Board.

Practical Considerations: Mechanics of Implementing Article 8 Opt in, if Lender requires (continue)

94

• LP/LLC agreement should be amended at closing to reflect

−(i) affirmative Article 8 opt in

−(ii) no permitted amendment of such provision without secured party’s consent

−(iii) no merger without secured party’s consent unless such amendment restriction remains in force in any new or amended LP/LLC agreement. (DE’s LP/LLC statutes permit third parties to hold such consent rights.)

Practical Considerations: Mechanics of Implementing Article 8 Opt in, if Lender requires

95

• Secured party should obtain written irrevocable proxy coupled with interest (for voting on amendment to opt in provision of LP/LLC agreement and amendments arising from merger). Review state proxy laws for permitted duration, etc.

• Add covenants to loan documents or agreement with issuer that without lender’s consent

−(i) no Article 8 opt out

−(ii) no amendment of Article 8 opt in provisions

−(iii) no merger without secured party’s consent unless opt in provisions remain in agreement of surviving entity

−(iv) lender can have proxy to vote on Art. 8 elections and mergers.

• Require Article 8 opt in legend on the equity certificate

Perfection and Priority Issues

96

• Make sure the collateral description in the security agreement covers both investment property and general intangibles, in case the classification of the collateral shifts because of post-closing Article 8 elections.

• Since investment property can be perfected by 3 methods, always file a financing statement as a fall-back, even if asset is otherwise perfected by possession or control

Perfection and Priority

97

Opinion issues: Law governing perfection for general intangibles (9-301 and 9-307) Law governing perfection for investment property (9-305) • While security certificate is located in jurisdiction, local

law of that jurisdiction governs • for uncertificated securities, local law of issuer’s

jurisdiction governs (8-110(d)) • for securities entitlements or securities accounts, local

law of securities intermediary’s jurisdiction governs (8-110(e))

Investment Property: Securities Accounts

98

• Definitions

−Securities Account – 8-501(a)

• account to which financial asset is credited in accordance with agreement with intermediary undertaking to treat the customer as entitled to exercise the rights that comprise the financial asset

−Financial Asset – 8-102(a)(9)

• security

• obligation/participation dealt or traded on financial markets or recognized as medium for investment

• any property expressly agreed upon by customer and intermediary

• LP/LLC interest held in a securities account

−Security entitlement – 8-102(a)(17)

• bundle of rights of an entitlement holder with respect to financial asset

• issuance of a security is not a security entitlement

Investment Property: Creation of Security Interest in Securities Accounts

99

• Security interest becomes enforceable against the debtor with respect to any investment property if −value has been given

−debtor has rights in the securities account and

−either (i) the debtor has authenticated a security agreement that provides a description of the securities account or (ii) secured party has control under 9-106 pursuant to debtor’s security agreement 9-203

Perfection of Security Interest in Securities Account

100

• Perfection can achieved by filing and/or control

−Secured party has control of security entitlement if:

• secured party becomes entitlement holder

• securities intermediary agrees it will comply with entitlement orders originated by secured party without further consent of entitlement holder

• another person has control on behalf of secured party and acknowledges 9-106, 8-106(d)

Practical Considerations for Securities Account Control Agreements

101

Intermediary’s agreement to follow secured party’s entitlement orders

Debtor’s access to securities account

Financial assets election and treatment of cash

Delivery of collateral endorsed to the securities intermediary or in blank

Subordination of intermediary’s lien

comments to 8-106 regarding delayed vs. present right to control disposition of financial asset

local law of securities intermediary’s jurisdiction governs perfection; parties can choose (8-110(e))


Financing Intellectual Property: Intersection of UCC Article 9 and Federal Law – Janet M. Nadile, Simpson Thacher & Bartlett LLP

Aircraft, Marine Vessels and Other Transportation Assets – R. Andrew Richards, McCarter & English, LLP

Insurance – Joseph K. Hegedus, Lewis Brisbois Bisgaard & Smith LLP

LP and LLC Equity Interests and Investment Property Issues –



Thursday, February 14, 2013

Sponsored by the Legal Publishing Group of Strafford Publications



212.455.3722

[email protected]


212.609.6840

[email protected]

Joseph K. Hegedus, Lewis Brisbois Bisgaard & Smith LLP

213.680.5116

[email protected]


Documents

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