Protecting Your Right to Get Paid Vol. 2: Filing Security Interests

In my last post, I discussed the value of establishing a security interest to protect your right to get paid when you extend credit terms.  In this post I will discuss how to establish a security interest when you sell an aircraft part (and in my next post I will discuss how to establish a security interest in aviation maintenance transactions). I also discuss the concept of perfection, which helps to give your lien priority over other later-filed liens.

The typical security interest is reflected by two documents.  The first document is called the security agreement.  The second document is called the financing statement.  In addition to these two documents you generally need to think about how you will “perfect” the security interest. 

Security Agreement

A security agreement is the record that describes the relationship that gives rise to the security interest. It can be a stand-alone agreement or it can be part of a larger agreement (like a sales agreement). A conditional sales contract can be one form of a security agreement. In order to have a valid security agreement, you typically need to include:

• A description of the asset that is secured by the Agreement (a “reasonable identification” sufficient to allow others to identify the collateral)
• A signature or other authentication from the debtor (to confirm the Agreement)

In order to support a security agreement, there should be an exchange of value (known as “consideration”) and also the debtor should have the right to grant a lien in the asset (this includes the rights obtained through a purchase of the asset, even though the purchase is conditioned on the security agreement). One example of how this works is if a buyer purchases on credit, and signs a sales agreement that includes a security agreement, then the buyer’s promise to pay is part of the consideration, and the buyer’s acceptance of the asset gives the buyer the power to grant a lien against the title to the asset.

Most security agreements are going to be far more complicated than these simple bullets, above. Typical feature of the security agreement will often include:

• Identification of the parties to the transaction (who is the debtor and who is the creditor)
• The amount that is secured
• Payment terms
• Terms of default (e.g. when can the creditor foreclose)
• Remedies in the event of default
• Potential limits on what the debtor can do with the asset before it is fully-paid

The FAA has a template for an Aircraft Security Agreement when a security interest or other lien is established against an aircraft.

Financing Statement

A financing statement is used for giving the world notice of your security interest; as a consequence it will look a little bit like a summary of the key points in your security agreement.  A typical financing statement must include the following three elements at a minimum:

• the name of the debtor;
• the name of the secured party (generally, the creditor); and
• the identification of the asset (collateral) covered by the financing statement.

Because the purpose of the financing statement is to provide notice of a security agreement, it allows such a notice to be provided without disclosing all of the elements of the security agreement.

There is a standard form for financing statements called a UCC-1. It is published in the Uniform Commercial Code and thus appears in the state versions of the Uniform Commercial Code.

Filing for Perfection

The terms of the security agreement will typically apply to the parties to that Agreement. But how do we make sure that it provides the creditor with priority against other creditors?

There is a concept in secured transaction law called “perfection.” The concept of perfection is that you need to do something in order to secure your rights relative to the rest of the world. Perfecting your lien typically give you priority against other lien holders who might perfect their liens at a later date.

It is normal to file a financing statement to perfect a lien. One important exception is that if you seek to perfect a lien by filing it with the FAA, then you will file the security agreement instead of the financing statement.

If you fail to perfect your lien then other lien holders who perfect their liens may take a priority over your rights, which means that in the event of a cash disposition of the collateral (like a judicial sale / auction), the other lien-holders with priority get their money first from the cash disposition proceeds.

Most normal rules to follow on how to accomplish perfection of a lien will be found in the state law of the state where the asset (collateral) can be found. So if the asset is added to an inventory in Florida, then Florida law typically applies. Although the Uniform Commercial Code helps to standardize commercial law, the specifics of perfection nonetheless vary from state to state.

Where Do You File?

Where to file can be a complicated question, especially in aviation. It is a question that is going to be based on state law. States can have different requirements about where and how to file and you need to identify the state whose law applies to the collateral.

Federal law can also influence filing requirements. Liens against aircraft, and certain engines and propellers, are filed with the FAA Registry Office in Oklahoma City. There are some state laws that specifically allow you to claim a lien in an aircraft if you furnish goods or services for that aircraft, so this may allow some parts sales transactions to yield a lien against the aircraft (but such a lien would likely be junior to other previous-perfected liens). If you establish a lien against an aircraft then you definitely want to file it with the FAA Registry to perfect it.

Some state laws can also require simultaneous filing with the state. The purpose of the federal registry was to preempt state filing laws, but state laws affecting the underlying validity of a lien will tend to be applied. If there is a state law requiring filing then you may want to follow both the state law and federal law in your filing practices, especially if past case law has been inconsistent in your jurisdiction. This is particularly true in cases of aircraft parts.

When it comes to aircraft parts, there are laws that permit some transactions (like transactions in air carrier parts) to be filed with the FAA registry. This can be found in federal laws and regulations, and you can find corollary requirements for federal filing in the laws of some states. Case law has even explained that if the collateral for a security agreement consists of “spare parts maintained by or on behalf of a certificated air carrier” then the security agreement must be filed with the FAA in order for the lien to be perfected. In re Avair, Inc., 98 B.R. 261 (Bankr. W.D. Va. 1988). The problem is that as a practical matter, the FAA Registry will not accept a filing of a lien in one or more discrete aircraft parts. Some courts have chosen to ignore this fact, and declared that federal filing for spare parts is nonetheless a necessity. It appears that filing the lien with the federal government (even if the filing is rejected) may be sufficient in some transactions but a state filing for a spare parts lien is probably a good idea (in many states) to ensure your lien perfection is recognized.

Failure to properly perfect the lien can mean that other (perfected) liens take priority over your lien. It can also mean that your non-perfected lien might be avoided by a bankruptcy trustee (treated as if there was no lien at all). For this reason it makes sense to work with an attorney to identify the sort of transactions that you want to secure, and to identify the compliance path for securing those transactions.

When the Security Interest Has Been Paid

Most states (and the FAA’s registry, too) have rules that say that when the lien has been paid, you must file a release statement expressing this full payment with the filing office. This action shows the world that the previously-filed security interest has been satisfied and no longer affects the title to the asset.