What Happens When a Lender Erroneously Describes Its Collateral as Inventory Rather Than Equipment?
 
July 27, 2004
 
Michael Weissman - Chicago

The Indiana Court of Appeals was asked to decide whether an error in describing collateral as inventory rather than equipment was serious enough to invalidate a security interest in Fifth Third Bank v. Comark, Inc., 792 N.E.2d 433 (Ind. App. 2003).

In July of 2000, Vertica, LLC purchased computer products from Comark for $2.8 million and Comark took back a purchase money security interest. In the security agreement the property was described as “inventory” followed by a rather detailed description of various computer components. The components were specifically identified as bearing the tradename or distributed by Comark, Inc. or PC Wholesale. In August 2000, Comark filed a UCC-1 to perfect a purchase money security interest in Vertica, LLC’s inventory again designating the collateral as an inventory of computer products bearing the tradename or purchased from Comark, Inc.

Subsequently, Fifth Third made a loan to an affiliate of Vertica, LLC called Vertica, Inc. and was misled into thinking that the assets of Vertica, LLC were actually the assets of Vertica, Inc. Fifth Third perfected a security interest against Vertica, Inc., but Vertica, Inc. had no assets.

When Vertica, Inc. defaulted on its loan from Fifth Third, a contest arose between Comark and Fifth Third as to which of them had a perfected security interest in the assets of Vertica, LLC.

Fifth Third attacked Comark’s security interest arguing that the misdescription of the collateral in Comark’s documents was a fatal error. The Indiana court did not agree raising two points it felt sustained Comark’s position.

First, it said that the test of the adequacy of a collateral description is whether it was sufficient to put an ordinarily prudent person on notice of a security interest. Citing In re Torgerson, 114 B.R. 899 (Bankr. W.D. Tex. 1990) in which a similar misdescription of collateral occurred, the court held that both the security agreement and the filed financing statement met the test of providing notice to third parties of the existence of a security interest. Indeed, the court said that “... under the Uniform Commercial Code great liberality is afforded in determining the sufficiency of the description of collateral.” Undoubtedly, the court was assisted in reaching its conclusion because the collateral description referred in detail to the type of goods and that the goods were Comark-branded.

Second, the court held that Fifth Third had no security interest in the collateral since its debtor, Vertica, Inc., had no rights in the collateral.

What’s the point?

While the collateral description was adequate to warn third parties a security interest existed, what if the description only mentioned “inventory” without the itemization of the collateral and the fact that it was Comark branded? Same result?

For more information e-mail Michael L. Weissman at michael.weissman@hklaw.com or call toll free, 1-888-688-8500.