Pre-Authorization of UCC 1 Financing Statement

The typical loan/credit scenario unfolds that a creditor will run various credit checks on a potential debtor and, as part of that search, will run a search of all existing UCC financing statements on the debtor. After approval, the creditor will then prepare documents, set up the customer, and prepare whatever business preparations are necessary for that creditor's line of business. The credit department, having done its due diligence, then green lights the transactions knowing that they are holding a first lien position and away we go.

However, this particular scenario can cause some probems since many things can happen to the debtor after they apply for credit and before the actual purchase of the goods intended by the loan transaction. Even setting aside those nefarious characters out there, even honest business people, particularly when setting up a new business, are applying for credit at all sorts of institutions. So what is a prudent credit department to do?

Well, best practices would dictate that not only should a creditor "re-check" the UCC statements and credit reports prior to first shipment (depending on the length of time of the delay that is typical between that business approving credit and first delivery), there is one other way to ensure the best lien position possible. What is that?

Pre-filing the financing statement (UCC-1).

In Texas and under UCC 9-509(a)(1), a creditor can pre-file a UCC-1 financing statement with authorization from the debtor. What's more, the "first in time" rule, even if the transaction is later consummated, would allow the creditor to be ahead of any subsequent filed similar UCC-1 financing statements (unless they have special priorities, like purchase money security interests).

So how does one get authorized? Well, there must be some intent from the debtor to grant some future security interest, so getting the debtor to sign a "pre-authorization" letter (or you could include same conspicuously in your initial credit application) should do the trick. Basically, if the debtor authorizes the pre-filing in writing, you will meet the standards of 9-509(a)(1). A simple signed letter can also do the trick. Now it should be noted that you will still have to terminate the financing statements according to the rules as if the transaction occured should the transaction not occur.

So don't wait for the loan file to be complete before filing your UCC-1's...file the financing statement at the very beginning and establish / lock in your security interest priority.

Texas Court: Deed of Trust Extinguished Upon Payment and Did Not Secure Additional Non Recourse Note

Generally, a deed of trust is extinguished upon payment of the indebtedness which it was created to secure even without a written release. However, if the deed of trust contains a dragnet clause, in some circumstances, the deed of trust may be found secure future indebtedness created after the original indebtedness was paid. A Texas Court recently analyzed these issues in Craig v. Ponderosa Development, LP.

A debtor executed a promissory note (“Note”) in favor of creditor. The Note was secured by a Deed of Trust against property owned by the debtor. The Deed of Trust contained both a dragnet clause and a release provision. A “dragnet” clause is a future advance clause. In other words, the dragnet clause in the Deed of Trust provided that the property secured both the Note and the payment of future indebtedness. The release in the Deed of Trust stated that “upon payment of all sums accrued by this Instrument, Lender shall release this Instrument.”

The debtor paid the full amount of the Note to creditor; however, creditor never released the Note or Deed of Trust. After debtor paid the Note in full, debtor executed a Non-Recourse Promissory Note in favor of creditor. Debtor defaulted on the Non-Recourse Promissory Note and creditor attempted to foreclose on the Deed of Trust. The creditor argued that the dragnet clause of the Deed of Trust covered the Non-Recourse Promissory Note.

A deed of trust has no legal effect apart from the debt it is intended to secure. A deed of trust is usually extinguished upon payment of the indebtedness which it was created to secure. Extinguishment is complete even without a written release. However, there may be an exception to extinguishment when the deed of trust contains a dragnet clause.

Texas courts do not recognize the enforceability of dragnet clauses unless the subsequent debt to be secured was reasonably within the contemplation of the parties to the deed of trust at the time it was executed. If the requisite intent is found, however, courts have indicated that dragnet clauses will be given effect even as to indebtedness created after the debt originally underlying a deed of trust has been paid in full.

In this case, the Court found that when read in conjunction with other provisions in the Deed of Trust, it was clear that the dragnet clause was not intended to secure future indebtedness created after the Note was paid in full. Any other interpretation would render the release in the Deed of Trust meaningless. The court concluded that the application of the dragnet clause to the Non-Recourse Note was not within the parties' contemplation at the time they signed the Deed of Trust.