The Wacky World of Accessions (9/99)
A client has asked us, "If I have a security interest in equipment which becomes attached to someone else's equipment, who has priority if the Lessee defaults to both of us?"
This is a common question, often creating confusion under the UCC. Briefly, the general rule is that a Lender's security interest in an item (an “accession”) is protected, even though the item is attached to a larger piece of equipment subject to a security interest in favor of a third party so long as (1) the Lender perfects its security interest before the attachment takes place and (2) the attachment does not cause the accession to become so integrated into the larger piece of equipment as to be non-severable. In the latter case, all is not lost. Instead of having a separate security interest, the Lender with the interest in the accession is given a pro-rata share of the collateral value of the entire equipment unit.
Under Section 9-314 of the UCC, a Lender's security interest is protected if, after the interest is perfected (usually by filing a UCC-1 financing statement), the accession is attached to a larger piece of equipment. In the event of a default, the accession may be removed by the secured party. If the Lender with an interest in the accession perfects the security interest after the accession is attached to the larger equipment its interest is protected against subsequent purchasers of the larger piece, but not against the interest of a secured party with a lien on the larger piece. In other words, in the event of a default, the secured party with a lien on the larger piece of equipment can foreclose on the entire unit, including the smaller item.
Another exposure to the first Lender comes under the general rule of the UCC that unperfected security interests lose out in favor of subsequent purchasers for value without notice. Section 9-314(3) makes it clear that such purchasers of the larger unit take free of any interest in the accession. The message remains "file promptly or perish".
How does this rule relate to Lessors? Section 2A-310 of the UCC creates a similar statutory framework, but without reliance on perfection.
If the lease contract is entered into prior to attachment of the accession (which will be the case except in sale-leasebacks or certain deferred payment situations) the Lessor prevails notwithstanding attachment. Where the lease is entered into after the leased property has become an accession to a larger piece of equipment, the Lessor's interest is subordinate to existing liens against the larger unit, but not to future purchasers of the larger unit who take with notice of the Lessor's title.
There are two notable exceptions to these rules, however: First, a buyer or lessee in the ordinary course of business of the larger piece of equipment takes free of the Lessor's interest. To be in the ordinary course, however, the sale must be essentially out of inventory or under some other situation fairly unusual where equipment leasing is involved.
The more serious risk comes under 2A-310(4)(b). This section provides that a creditor who has a security interest in the larger piece of equipment which was perfected before the lease contract was made maintains its superior interest in the entire unit (including the leased equipment) if subsequent advances are made "without knowledge of the lease contract. " In other words, a Lender with a lien on the larger piece of equipment who does not know of the attachment of a leased item is protected for future advances made under a line of credit or similar arrangement.
What all this means to equipment Lenders and Lessors is that a few simple rules will provide maximum protection:
- The Lease document should prohibit attachment of the leased item onto another piece of equipment without prior written consent.
- The Lessor, particularly if the Lease is not a true lease for UCC purposes, should always file a UCC-1 financing statement promptly.
- If the equipment is of a nature that it could be attached to another unit, such as a portable welding unit which can be attached to a pick-up truck or trailer, or certain types of computer equipment, the Lessor should obtain information as to Lessee's intentions and perform a UCC search. If there is any question that the equipment may be attached to another price of property, the other lender should be notified prior to the execution of the lease contract.
- Sale/Leasebacks should be carefully checked out in advance to ensure that the equipment has not already been attached to another unit.