Court of Appeals Upholds Security Interest Where Description of Property was Technically Inaccurate

Court of Appeals Upholds Security Interest Where

Description of Property was Technically Inaccurate

      In a decision rendered last Friday, the Kentucky Court of Appeals has upheld the security interest taken by a bank in personal property where the UCC-1 of record with the Kentucky Secretary of State accurately described the collateral, but where the incorrect serial number was listed.  Bishop v. Alliance Banking Co., No. 2012-CA-001605-MR (Ky. App. Oct. 11, 2013).  This opinion has been designated “To Be Published.”

      Timothy and Candace Elkins delivered a promissory note to Alliance Bank, which note was partially secured by a 1999 Case backhoe.  Alliance filed a UCC-1 with the Kentucky Secretary of State perfecting their security interest in that backhoe, describing it as a “1999 Case Backhoe 580L” and reciting a serial number of 1100249697.  Later that year Elkins defaulted on the note, whereupon the bank filed an action for breach and to obtain possession of the backhoe.  Elkins never defended the action, and a default judgment was entered in favor of the bank.  In addition to an award of damages and for attorney’s fees, the trial court determined that Alliance held a perfected security interest in the backhoe and granted it possession thereof.

      It turned out, however, that between entering into the note/collateral agreement with Alliance and Alliance bringing action for default, Elkins had sold the backhoe to Bishop.  Alliance, upon learning of this sale, moved to amend its complaint to add Bishop as a defendant.  Also, at the time of finding out about the sale of the collateral to Bishop, Alliance learned that Timothy Elkins’ representation of the serial number, which serial number was recited on the financing statement, was incorrect; rather, the correct serial number JJG0249697.  Bishop would argue that the incorrect serial number on the UCC-1 meant, inter alia, that he was not on notice of Alliance’s security interest and that he otherwise purchased the backhoe in good faith, for value and without knowledge of a prior claim thereon.  This position was rejected by the trial court, and that rejection was affirmed by the Court of Appeals.

      Notwithstanding the fact that the serial number listed on the UCC-1 of record with the Kentucky Secretary of State was incorrect, the two serial numbers overlapped by six digits.  Further, the financing statement did properly describe the equipment as a “1997 Case backhoe, 580L.” Applying the “inquiry test” of the UCC, and citing Nolin Prod. Credit Ass’n v. Canmer Deposit Bank, 726 S.W.2d 693, 697 (Ky. App. 1986):

[A] description of collateral is sufficient for either a security agreement or a financing statement if it puts subsequent creditors on notice that, aided by inquiry, they may reasonably identify the collateral involved.  (Slip op. at 5).

      Bishop also argued that he had contacted the Powell County Court and had been advised that there were no recorded liens against the Case backhoe.  The Court of Appeals ascribed no importance to this action, it being at the Kentucky Secretary of State that inquiry with respect to security interests is to be made. 

      Prospectively, in language quoted by the Court of Appeals, the trial court had indicated the protocol that should be implied in order avoid problems of this nature:

Bishop was under a duty to make an inquiry of the Secretary of State’s UCC records and if such inquiry was made [Bishop] would have found that [Alliance Bank] was claiming an interest in an 1999 Case backhoe 580L Serial # 1100249697.  [Bishop] would then have noticed the similarities between the serial numbers on [Alliance Bank’s] collateral and the one he was proposing to buy from [Elkins].  [Bishop] would have asked [Elkins] how many 1999 Case backhoe 580L[s] he owned and he would have called [Alliance Bank] and inquired as to whether [Alliance Bank] claimed any interest in the backhoe [Bishop] was about to purchase. (Slip op. at 2-3).

      Clearly a purchaser has due diligence obligations in order to ensure they are a purchaser in good faith without notice of prior claims.  Furthermore, it would well behoove lenders to insist upon verification of equipment serial numbers.