Seventh Circuit Says Secured Party[acute accent]s Signature Is Not Needed to Validate a Security Agreement. Is This Correct?

The United States Court of Appeals for the Seventh Circuit ruled in In re Vic Supply Company, Inc. (Falconbridge U.S., Inc. vs. Bank One Illinois, N.A.,), 227 F.3d 928, 42 UCC Rep. Serv. 2d 385 (7th Cir., 2000) that a bank did not have to sign a security agreement in order for it to be effective against third parties, despite the fact that the agreement specifically stated that it would become effective only when "accepted by the Bank."

The case arose as a dispute between two creditors of a bankrupt company known as Vic Supply Company ("Vic"). One of the creditors was Bank One, which presumably had a first priority security interest in all of the assets of the debtor to secure loans made prior to bankruptcy. The other was Falconbridge U.S., Inc., which had a purchase money security interest in metal sold to Vic including the proceeds from the resale thereof.

Bank One had begun providing financing to Vic in 1980 and it filed a blanket UCC financing statement with the Secretary of State of Illinois in that year. Ten years after the initial document execution, Bank One continued to provide financing to Vic and Vic signed another agreement continuing Bank One's security interest in all of Vic's assets, including proceeds from the sale of inventory. Bank One filed continuation statements, continuing the filing made in 1980.

The relationship between Vic and Bank One went on for a number of years. Later, Falconbridge filed a financing statement to perfect a purchase money security interest in the metal it was selling to Vic, which automatically extended to the proceeds of Vic's resale of the metal.

When Vic went into default, Falconbridge sought some way to prime Bank One's security interest. Falconbridge could not claim a superpriority in the proceeds from the sale of the metal based upon its purchase money security interest because Vic had received accounts receivable rather than cash from the sale of the metal.

However, Falconbridge seized on another point. In the course of discovery, Falconbridge learned that Bank One hadn't signed the 1990 security agreement. Seizing upon this point, Falconbridge pointed out to the court that the security agreement expressly provided that: "the terms and provisions of this Agreement shall not become effective and Bank shall have no duties hereunder unless and until this Agreement is accepted by Bank as provided below" with a blank for a signature that was never affixed. As a result, Falconbridge asserted that Bank One did not have a security interest that primed Falconbridge's security interest.

The Seventh Circuit considered two issues: whether Falconbridge had standing to challenge Bank One, and whether the absence of Bank One's signature on the security agreement meant that Bank One had failed to take the steps necessary to create a valid security interest.

The Court disposed of the first point with the application of the old "no harm, no foul" rule. That is, it held that Falconbridge had no standing to challenge the alleged defect because it was in no way harmed by the absence of signature. The Court noted that Falconbridge had done a UCC search prior to extending credit and, therefore, was not prejudiced by the absence of a signature. Falconbridge also had served Bank One with written notice of its claim of a security interest. It was clear that Falconbridge knew Bank One was claiming a security interest.

The second point was more difficult. The Court noted the language of Old UCC Section 9-203(i)(a), which speaks in terms of the debtor having signed a security agreement1 containing a description of the collateral and observed that some courts have used this language to eradicate the priority of an earlier creditor without requiring any proof that the competing creditor was prejudiced by the absence of signature or any other defect in the security agreement. (World Wide Tracers, Inc. v. Metropolitan Protection, Inc. 384 N.W. 2d 442 (Minn. 1986); In re Middle Atlantic Stud Welding Co., 503 F.2d 1133 (3rd Cir. 1974). The Seventh Circuit said that it did not favor this result because it provided the competing creditor with a windfall by enabling it to seize upon a defect of which it was unaware when it extended credit. It also felt it was noteworthy that Section 9-203(i)(a) called for the debtor's signature, but not the secured party's creating an inference that the drafters of the Code did not think the secured party's signature was necessary.

It is interesting to note that there was a concurring opinion by Judge Williams, who agreed with her colleagues that Falconbridge lacked standing to mount a challenge but dissented from the majority's conclusion that the security agreement was valid in light of the language that stated it became effective if and only when Bank One had signed it. She said it was telling that the majority opinion (written by Chief Judge Posner) did not cite a single case to support its position on the absence of signature by Bank One and concluded with this comment: "No rule of law of which I am aware allows us to disregard the unambiguous terms of a contract in favor of what we believe the parties must have intended. Again, our task is to enforce the terms the parties included in their contract."

What's the point?

Obviously, this case points out the necessity for lenders to carefully complete loan documents lest they be challenged at a later date. Even if the challenge of a bank's priority position is unsuccessful, the cost of litigation is substantial.

1 9-203(b)(3)(A) of Revised Article Nine continues the rule of its predecessor except that it now speaks in terms of "authentication" rather than signature.

The content of this article does not constitute legal advice and should not be relied on in that way. Specific advice should be sought about your specific circumstances.

Mr Michael Weissman

Holland & Knight LLP 

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