USA Law and Practice Contributed by: Stelios G Saffos, Dan Seale, Peter Sluka and Alfred Xue, Latham & Watkins LLP
5.7 Rules Governing the Priority of Competing Security Interests and/or Claims In the United States, borrowers often incur multiple financings with different lenders, each secured by a valid and enforceable security interest in a common pool of collateral. The UCC provides statutory rules to determine priority of competing liens in personal prop - erty collateral. Among secured creditors, a perfected security interest has priority over an unperfected one. Among creditors with perfected liens, a security inter - est perfected by control or possession generally has priority over a security interest perfected only by a UCC-1 financing statement filing, and among credi - tors that perfect only by UCC-1 filing, the first in time to file generally has priority. The most notable excep - tion to the first-in-time rule is the priority given under the UCC to creditors secured by a purchase money security interest (PMSI) so long as the PMSI lender complies with the filing (and, in case of inventory, noti - fication) requirements within the period set forth under the UCC. The statutory rules of priority under the UCC can be altered contractually by the lenders, typically in an intercreditor agreement entered into by the different lenders (or their agents) and acknowledged by the grantors. Intercreditor agreements are generally held to be enforceable in accordance with their terms by the bankruptcy court under Section 510 (a) of the US Bankruptcy Code. Intercreditor agreements estab - lish lenders’ relative priorities in common collateral, whether as first lien/second lien, pari passu (or equal) lien, or split lien (ie, first lien in one pool of collateral and second lien in the rest), including enforcement or exercise of remedies with respect to the collateral upon default under the financing agreements and order of payment from proceeds of the collateral, including under 363 sale or other collateral liquida - tions in case of bankruptcy of the borrower group. 5.8 Priming Liens and/or Claims Liens arising by operation of US state or federal law are wide-ranging. Liens may arise in connection with unpaid taxes, judgments, goods in possession of bailees, shippers or service providers, landlords, depositary institutions providing financial services to their customers, and numerous federal statutes applicable to agricultural products, to name a few. In
many cases, the general rules of Article 9 of the UCC establish lien priority as among competing interests, but in some cases, either the UCC expressly defers to another statutory priority scheme or, in the case of federal law or international treaties, the UCC priority rules are pre-empted. Parties are generally permitted to contractually alter their priority in collateral, and thus a party with a priming statutory lien may volun - tarily agree to subordinate its lien to that of a secured lender, but in many cases a secured lender avoiding a priming statutory lien is not feasible. Liens arising by operation of law are often applicable solely to spe - cific assets and/or secure only specific obligations, so with routine diligence lenders may be comfortable that the impact of any such actual or hypothetical liens is negligible in the context of the overall transaction or otherwise draft covenants to mitigate the risk. 5.9 Cash Pooling and Hedging/Cash Management Obligations Under the UCC, deposit accounts as original collateral may only be perfected by “control”, the most com - mon method in secured lending transactions being a deposit account control agreement entered into between the debtor, the secured party and the deposi - tary bank. A UCC-1 financing statement is ineffective to perfect in deposit accounts as original collateral. Because of this, it is common for private credit trans - actions to either exempt deposit accounts from the perfection requirement or, in some cases, partially or entirely exclude deposit accounts from the collateral. A depositary bank has an automatically perfected lien under the UCC over the deposit accounts of its cus - tomer and a secured lender wishing to obtain prior - ity over such lien will need to obtain the depositary’s agreement to subordinate its interest. However, this is moot in lending transactions where deposit accounts either are not required to be perfected or are excluded from the collateral. It is common for secured hedges and cash manage - ment obligations to be secured by the same collateral that secures private credit transactions. Most often, these interests are secured under the same collateral documentation as the bank loans and such obliga - tions are secured on a pari passu basis.
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