ELFA - Equipment Leasing and Finance Association - Equipping Business for Success

Issue

Equipment Leasing & Finance
Leasing Law

When Goods and Realty Collide: Come Together

May-June 2022

Security interests in goods, such as equipment, are generally determined by Article 9 of the Uniform Commercial Code (UCC). However, if equipment is attached to real estate in a way that allows rights to arise under real property law, such goods become fixtures. This merging of the UCC and property law is important because it influences how lenders secure first priority liens in fixtures. This article begins by discussing the definition of fixtures. Next, it provides examples of items that may constitute fixtures. Lastly, this article examines how equipment finance lenders secure first priority liens in fixtures. 

Fixtures Defined: [Can’t] Shake it Off!

Goods“Fixtures” is defined by UCC Section 9-102(a)(41) as “goods that have become so related to particular real property that an interest in them arises under real property law.” Although the UCC defines fixtures, the description provides little practical guidance. Thus, an examination of real estate case law is important to ascertain if certain goods, when affixed to real property, become fixtures. Unfortunately, the law is not always clear and whether goods convert to fixtures rests primarily on the underlying facts and circumstances of each case. Many courts consider the following factors: 

1. Annexation. Annexation refers to the physical attachment of the goods, either actually (e.g., nails, screws, bolts) or constructively, to the real property. Although not consistently followed, some courts have held that an item is a fixture if its removal would damage the real property.

2. Adaptation. Adaptation means the design of the real estate specifically included the goods as an integral part of the property. For example, a building is designed explicitly to include a heating system (i.e., fixture).

3. Intention. Intention examines the actual intent of the annexing party to make the goods a permanent part of the property. Usually inferred from the circumstances, intention must be shown by some objective manifestation to put third parties on notice. For example, courts consider how firmly the goods are attached and the difficulty of removing the goods. Intent of the parties is important and should be reflected in the documentation. However, depending on the applicable state, intent will not be the only relevant factor.

Goods2

Perfecting Security Interests in Fixtures: Lien on Me

Under the UCC, lenders can perfect a security interest in fixtures in the following ways: 

1. UCC-1 Filing. File a UCC-1 financing statement covering the fixtures in the office designated by Section 9-501(a)(2), which, in most states, is the state central UCC index (Article 9 index).

2. Fixture Filing. File a “fixture filing” under Section 9-102(a)(40) complying with Section 9-502(a) and (b). Subsection (b) lists the “fixture filing” specific items needed beyond the general UCC-1 financing statement requirements, including a description of the real property to which the fixtures are related. In most states, a “fixture filing” must be filed in the office designated for the filing or recording of a mortgage on the related real property. A “fixture filing” will not perfect a lender’s interest in non-fixture goods. Accordingly, a UCC-1 filing is always recommended where the goods may not meet the definition of a fixture.

3. Record of Mortgage. Record a record of mortgage in the real property records covering fixtures. If a record of mortgage satisfies the requirements of Section 9-502(c), it is effective as a “fixture filing.” 

Lien Priority in Fixtures: Don’t Want to Lose You

Below are some practical guidelines for lenders to consider concerning lien priority in fixtures.

1. UCC-1 Filing. If a lender perfected its interest in fixtures by filing only in the Article 9 index (not the real property records), it would be senior to later filed conflicting security interests that were filed only in the Article 9 index. However, unless an exception exists, an Article 9 index filing awill always be junior to a conflicting lien in fixtures recorded in the real property records by any party other than the debtor without regard to the time of filing

2. Exceptions: Consent & Trade Fixtures. There is an exception under Section 9-334(f) if the conflicting owner or encumbrancer has consented to the security interest (often via a landlord or mortgagee waiver) or if the debtor has the right to remove the fixtures pursuant to the real property lease. Another exception under Section 9-334(e)(2) is a UCC-1 filing on fixtures takes priority over a recorded real property interest if, before the goods become fixtures, the security interest is perfected and the fixtures are readily removable goods of a specified type (i.e., certain trade fixtures). Given the fact-sensitive nature of whether goods are trade fixtures, lenders should tread with caution when considering relying on this exception. 

3. Fixture Filing. Generally, lenders must file a “fixture filing” to obtain priority over conflicting real property interests in fixtures. Subject to the above exceptions noted in (2), a “fixture filing” takes priority over a conflicting UCC-1 filing. Further, a “fixture filing” (including a record of mortgage satisfying the requirements of Section 9-502(c)) takes priority over conflicting real property interests if it was perfected before the conflicting real property interest is recorded (i.e., first to file). 

4. Exception: PMSI. Under Section 9-334(d), a perfected security interest in fixtures takes priority over an earlier recorded real property interest if the debtor has an interest of record in or is in possession of the real property and: (i) the lender’s interest is a purchase-money security interest (PMSI), (ii) the encumbrancer’s or owner’s interest arises before the goods become fixtures, and (iii) the lien is perfected by a “fixture filing” before the goods become fixtures, or within 20 days thereafter. Notably, Section 3-334(h) contains an exemption 
to this exception. A PMSI in fixtures is subordinate to a construction mortgage if a record of such mortgage is recorded before the goods become fixtures and the goods become fixtures before the completion of construction. 

Special Considerations. Different rules apply for transmitting utility debtors, including duration of the security interest (9-515(f)) and manufactured-home transactions (9-334(e)(4)). 

Continuation of Financing Statements & Fixture Filings: Don’t Go Breaking Our Hearts

Under UCC Section 9-515(a), a filed financing statement (including a “fixture filing”) is effective for five years after the filing date and can be continued for successive 5-year periods. There are exceptions, including under Section 9-515(g), a record of mortgage which is effective as a “fixture filing” remains effective as a financing statement until the mortgage is released or satisfied of record or its effectiveness otherwise terminates as to the real property. 

Conclusion: The End

The above “Fixtures Test” should be a helpful tool for equipment lenders but it is not a bright-line rule. Therefore, where collateral may encompass fixtures, lenders should file both a UCC-1 and a “fixture filing.” Furthermore, lenders should take into account the general priority rules (and exceptions) applicable to both goods and fixtures. It is also important to stress there are several state-specific variations, nuances and exceptions that need to be considered, which are not fully addressed in this article. Lenders should consult their own legal counsel. By taking all steps necessary to perfect a first priority lien in its collateral against all its debtor’s secured creditors (personal and real property), lenders will ensure that if their debtor defaults, such lender may remove its collateral from the premises —whether goods or fixtures—without having liability to the debtor’s secured creditors.  

Categorized With:

  • LEGAL RESOURCES