Presiding over Puerto Rico’s financial restructuring, District Judge Laura Taylor Swain explained the dangers of incorporation by reference when perfecting a security interest.
Puerto Rico’s retirement system was authorized by statute to issue secured debt. Commonly known as ERS, the retirement system issued bonds in 2008 that were to be secured by ERS’s revenue, among other things. The UCC-1 financing statement described the collateral as the property shown on the security agreement that was attached.
However, the security agreement described the collateral as having the meaning defined in the statute that authorized issuance of secured bonds. The statute or its definition of collateral was not attached to the financing statement.
In 2015, UCC-3 continuation statements were filed, and they contained complete descriptions of the collateral. However, the continuation statements identified the debtor as ERS but did not use the new, official name that had been given to ERS after the bonds were issued.
Acting on behalf of ERS in Puerto Rico’s debt adjustment proceedings under the Puerto Rico Oversight, Management, and Economic Stability Act, or PROMESA (48 U.S.C. §§ 2161 et. seq.), the island commonwealth’s Financial Oversight and Management Board sought a declaratory judgment that the bondholders’ security interest was unperfected and could be avoided under Section 544(a), incorporated by Section 301 of PROMESA.
In a 32-page opinion on August 17, Judge Swain granted the Board’s motion for summary judgment and declared the security interest to be unperfected.
Judge Swain’s analysis was straightforward and comparatively simple. Although a financing statement need only “reasonably” identify the collateral under UCC § 9-110, she cited caselaw for the proposition that a collateral description by reference may only refer to a document attached to the UCC filing or to another document on file in the UCC clerk’s office.
Judge Swain therefore held that the original UCC-1s in 2008 failed to perfect the security interest. The UCC-3s in 2015 fared no better.
Between the issuance of the bonds in 2008 and the filing of the continuation statements, the formal name of ERS was changed. The UCC-3s referred to ERS, not to the retirement system’s new, formal name.
Under UCC § 9-503(a)(1), the debtor’s name on a financing statement must be the name “on the public organic record most recently filed with or issued or enacted by the registered organization’s jurisdiction.” The debtor’s trade name is insufficient under UCC § 9-503(c), according to Judge Swain.
The UCC-3s failed to perfect the security interest, Judge Swain said, because ERS “functions as a trade name, the use of which Article 9 expressly provides is insufficient.”
To salvage the security interest, the bondholders argued that the Board could not use Section 544(a) to invalidate a security interest granted before the enactment of PROMESA. In that respect, Judge Swain conceded that statutes are “ordinarily construed as prospective only.” She also said that the Bankruptcy Code has been interpreted to be prospective only.
However, she said that “PROMESA was enacted specifically to enable Puerto Rico to address its current debt crisis.” To apply Section 544(a) only to bonds issued after the enactment of PROMESA “would . . . eviscerate (directly and by implication) the availability to Puerto Rico of lien avoidance mechanisms that are the core debt relief tools,” Judge Swain said.
Judge Swain went on to say that “the incorporation of the arsenal of avoidance powers into PROMESA would have been meaningless, in addressing Puerto Rico’s financial situation, if they could only be invoked in connection with debt incurred . . . following the enactment of the statute.”
Judge Swain therefore held that Section 544(a) could be employed retroactively to avoid an unperfected security interest granted before the adoption of PROMESA.
The bondholders are appealing.