11.03.2020 | Articles

Why Do We Care About a Change in a Borrower’s Name?

By David C. Phalen, Brian F. Plunkett
Commercial Real Estate

A secured party needs to be alert to a change in a borrower’s legal name since a name change can affect the priority of a lender’s security interest.  In order for a lender to obtain a “perfected” lien on business assets such as accounts receivable, equipment and inventory, a lender must, among other steps, prepare and file a UCC-1 Financing Statement (a “UCC”).

To prepare a valid UCC, the lender must accurately insert certain information in the UCC financing statement and then file it in the proper filing office which is usually the state of formation for the Borrower.  It is very important that the UCC contain the borrower’s exact legal name.  This is critical for complying with the so-called “search logic” used by the UCC filing office (usually the Secretary of State’s office in the state of formation of the borrower) which is intended to enable other parties to determine what priority is held by a secured party.  Assuming a secured party has met the other requirements for obtaining and perfecting its lien on a borrower’s assets covered by the UCC financing statement (which other requirements are beyond the scope of this post), the first lender to file a valid UCC holds a first priority lien on those assets.  Lien priority is crucial if the borrower defaults on its loan.  The lender that filed first gets repaid first from the liquidation of the borrower’s assets and if there is nothing left after paying off that first priority lender then the lender holding a second priority lien will not receive any payment from the sale of the borrower’s assets and, absent a personal guarantee or alternative collateral, will not be repaid.

It is not unusual, however, for a borrower to change its name after a loan has been made to a borrower.  This can happen for any number of reasons but is easily accomplished by the borrower filing a simple form with the Secretary of State and paying a modest filing fee.  New lenders considering lending money to a borrower will conduct UCC searches and file their UCCs under the new name of the borrower, not the old name.  Thus the question arises as to which lender will have a first priority lien on the borrower’s assets, the one that filed under the old name or the one that filed under the new name?  The general rule is that there is a four (4) month “safe harbor” for the existing lender that filed under the old name.  That means that for the first four (4) months after the date of the name change, the lender that filed under the old name will continue to have a first priority lien on the borrower’s assets named in the UCC.  However, after the four months is over, unless the first lender has filed an amended UCC noting the name change of the borrower, then the first lender will no longer have a first priority lien on any of the assets acquired or created by the borrower more than four months after the name change.  This means the lender would no longer have a first priority lien in accounts receivable created and inventory and equipment purchased more than four months after the name change. The new lender (which filed under the new name) would thus have the first priority lien on those after-acquired assets. The original lender’s lien would continue with respect to assets still owned by the borrower that were acquired prior to the name change and for four months thereafter but the loss of priority on the newly acquired assets is typically a major problem for a lender.

While most loan agreements contain a covenant that requires a borrower to obtain the lender’s consent to any change in a borrower’s name, state of organization or amendment to the borrower’s organizational documents, a covenant is merely a promise and does not adequately protect a secured lender in a name change situation.  If, despite this promise, the borrower changes its name without informing the lender, then after the passage of four (4) months the lender could still lose its first priority lien in the newly acquired assets to another lender.  If the borrower is making a fundamental change in its business such as merging with another business, issues like name changes will normally be discussed with its lender but if the name change is due to a new marketing plan, a borrower may not think to notify its lender. 

Lenders need to be aware of how significant a borrower’s legal name is and should be alert to any indication from a borrower that a name change may have occurred or may be contemplated.  If a lender discovers a name change, it is crucial to promptly check with the state filing office and, if necessary, to file an amended UCC to preserve the lender’s first priority lien position.  If a lender discovers that a name change has occurred after the four-month safe harbor period, it is important to immediately conduct an updated UCC search to determine whether any new UCCs have been filed.  If so, it may be necessary to require a borrower to obtain the subordination of those new UCCs in order to reinstate the lender’s first lien position.  If the borrower or the new secured lenders are not cooperative, it may then compel the original lender to declare an event of default.  

A change in a borrower’s name can have unexpected and quite dire consequences if a lender does not recognize the need for action on its part.  Borrowers are also well advised to make sure their lenders are aware of pending name changes and have taken the necessary steps to continue their lien perfection in order to avoid unnecessary events of default and the resulting legal costs involved in finding a solution to an unanticipated problem.  This is why we care about name changes! 

This communication is for informational purposes only and should not be construed as legal advice on any specific facts or circumstances.

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