John M. McCabe
Legislative Director / Legal Counsel
jmmccabe@nccusl.org

September 15, 2000

Memo to: Interested Parties

Subject: Revised Article 9 of the Uniform Commercial Code
Concerns for a State That Fails Timely to Enact Revisded Article 9: The Choice of Law Problem

Revised Article 9 of the Uniform Commercial Code contains a uniform effective date of July 1, 2001, applicable to all states that enact the revisions. The Official Comments state that this uniform effective date was intended to give all states ample opportunity to enact the statute so that it would become effective on the same date throughout the country. The Official Comments caution:

If former Article 9 is in effect in some jurisdictions, and this Article is in effect in others, horrendous complications may arise. (emphasis added)

Those horrendous complications may be referred to as the "choice of law" problem.

This paper is intended to explain what the choice of law problem is and how it might negatively impact a state (an "Affected State") if the Affected State fails to enact Revised Article 9 so that it is effective on July 1, 2001.

The Choice of Law Problem in General

The choice of law problem relates to the concern that a litigation outcome relating to an Article 9 secured loan or other secured transaction may be determined by the location of the litigation. If litigation relating to an Article 9 secured loan or other secured transaction takes place in a court located in a state that has adopted Revised Article 9, the Revised Article 9 choice of law rules apply. But, if the litigation takes place in a court located in a state that has enacted former Article 9 and has not enacted Revised Article 9, the former Article 9 choice of law rules will apply. For example, if the collateral is ordinary goods, and perfection of a lender's security interest in the goods is claimed by means of the filing of a Uniform Commercial Code financing statement, Revised Article 9's choice of law rules require that the lender perfect its security interest in the goods by filing the financing statement under the laws of the jurisdiction of the debtor's location. The debtor's location would usually be, in the case of a business debtor that is a legal entity, the state under whose laws the debtor is incorporated or otherwise organized as a registered organization. However, former Article 9 requires that the lender perfect its security interest in the goods by filing the financing statement under the laws of the jurisdiction where the goods are located. Litigation might take place in a state court or in a bankruptcy or other federal court.

Lenders that would otherwise extend credit under the Revised Article 9 rules will not want to take the risk of litigation occurring in a court that, under the choice of law rules of the state in which the court is located, will apply former Article 9 to determine perfection. Lenders extending credit under Revised Article 9 rules applicable elsewhere in the country will accordingly be forced to protect themselves by complying with both sets of rules - former Article 9 and Revised Article 9 - so long as there is a possibility of litigation occurring in a former Article 9 forum.

The Choice of Law Problem for an Affected State

With that background in mind, several significant concerns for an Affected State arise if the Affected State fails to enact Revised Article 9 so that it is effective on July 1, 2001.

The Affected State's debtors may have higher transaction costs. Secured parties extending credit to an Affected State's debtors will need to comply with the perfection rules of both former and Revised Article 9. That will mean duplicate or at least more complex documentation and, in many instances, additional filing fees for Uniform Commercial Code financing statements. It will also mean that the lender's legal fees passed on to the Affected State's debtor would be higher.

The Affected State may lose some state revenues. To maximize its protection under Revised Article 9, a lender that would otherwise extend credit to a corporation or other registered organization organized under the laws of an Affected State may insist that the debtor reincorporate or reorganize under the laws of a state that has enacted Revised Article 9. That could mean loss of some revenues to the Affected State to the extent that the revenues would otherwise be derived from the debtor being incorporated or otherwise organized under the laws of the Affected State.

The Affected State may lose some inward direct investment opportunities. Lenders extending credit to debtors located outside of the Affected State may put restrictive covenants in their loan documents limiting a debtor's ability to open an office in the Affected State or to have goods located in the Affected State. That would be because the lender, having complied with the rules under Revised Article 9, would not want to incur the initial or ongoing monitoring costs of compliance with former Article 9, merely because the debtor opens or might open an office in the Affected State or has goods or might have goods located in the Affected State. That restriction may be an outright prohibition or one that requires that the lender be paid a fee for its extra initial or monitoring costs if an office is opened by the debtor in the Affected State or goods are maintained by the debtor in the Affected State.

The Affected State may see an increase in bankruptcies. The concern here may be best illustrated by an example.

Lender lends to Debtor and is granted a security interest in Debtor's assets under Revised Article 9. Lender complies with the perfection rules of Revised Article 9. Debtor later finds itself in financial trouble. Creditor discovers that Debtor has a sufficient presence in the Affected State to permit a bankruptcy venue in the Affected State. If a bankruptcy were commenced by or against Debtor outside of the Affected State in a state that has enacted Revised Article 9, the bankruptcy court would likely apply the Revised Article 9 choice of law rules, and Lender's security interest would be perfected. But, if a bankruptcy were commenced in the Affected State, the bankruptcy court in the Affected State would likely look to the Affected State's former Article 9 choice of law rules, which require that a financing statement must have been filed in the Affected State for the collateral in question. Without that filing, Lender's security interest is unperfected.

In this example, Creditor would have an incentive to commence an involuntary bankruptcy against Debtor in the Affected State, not because bankruptcy is a good idea for Debtor or its creditors generally but just to set aside Lender's security interest in those assets. (We can also posit an example where Lender insists that Debtor file bankruptcy prematurely in a state that has enacted Revised Article 9 in order to protect itself from an involuntary bankruptcy petition against Debtor being filed in the Affected State.)

The choice of law problem for the Affected State will be even more acute given the large number of states that have already enacted or will shortly enact Revised Article 9. Twenty-seven states, as well as the District of Columbia, have thus far enacted the statute; the statute in each of these states has an effective date of July 1, 2001. Bills are being prepared for introduction in January in all of the remaining states, and efforts are underway in those states to insure timely adoption so that the statute will be effective on July 1, 2001, in those states.

The Solution: the Affected State Should Timely Enact Revised Article 9

The choice of law problem will be eliminated, and these potential negative consequences for the Affected State will be avoided, if the Affected State enacts Revised Article 9 and all other states do likewise so that Revised Article 9 is in effect in all states by July 1, 2001. Even if not all states enact Revised Article 9 so that it is in effect in all states by July 1, 2001, the choice of law problem in the Affected State will be dramatically minimized if the Affected State joins the majority of states in enacting Revised Article 9 so that it is effective in the Affected State on July 1, 2001.

There are many reasons for the Affected State to enact Revised Article 9 so that it is effective on July 1, 2001. Solving the choice of law problem is only one of those reasons. In addition, early enactment well before the July 1, 2001, effective date would promote awareness of the statute among the Affected State's business, financial and legal community, accelerate educational and training efforts and procedures implementation and generally better prepare the Affected State for Revised Article 9 becoming effective in so many, if not all, states across the country on July 1, 2001.