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Landmark Ruling for Due Diligence in Secured Transations
A recent decision by the US Court of Appeals has a
significant impact on due diligence in secured transactions. In the
case, in re Spearing Tool and Manufacturing Col, Inc., the court
found that a previous IRS tax lien did trump a bank’s financing, even
though the bank submitted a lien search with the exact registered name
of the debtor and no notice of the IRS tax lien appeared. The IRS had
submitted a lien notice with the debtor’s name given on its tax return
and not the precise Michigan-registered name. The court held that the
bank failed at due diligence by not checking commonly used abbreviation
associated with a debtor’s name, even though the bank did check for the
name of the company as it appeared in the public record.
Uniform Commercial Code states that financing
statements sufficiently provide the name of the debtor, only if it
provides the name of the debtor indicated on the public record of the
debtor’s jurisdiction of organization which shows the debtor to have
been organized. UCC §9-503(a)(1). Although the IRS did not meet these
standards, the court still held that the bank failed at due diligence
for not searching the abbreviated name of the debtor.
The IRS filed under their customary procedure on a
name as it appeared on the “tax return.” The Court ruled that Federal
Law controls whether the IRS’s lien notice sufficed, and not state law.
The court found the IRS’s identification was sufficient even though a
search of the state UCC index would not have revealed the liens. The
state search would not find the liens because of strict search logic
which does not ignore certain words and abbreviations such as
“manufacturing” (mfg.) or “and” (&). However, still the court did hold
that bank failed at its due diligence.
Two suggestions for avoiding this type of problem:
- Require the debtor to provide front-page copies
of all tax returns for the past 10 years.
- Conduct a search with all conceivable variations
of the debtors name in all states that the debtor conducts business or
owns property.
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