A purchase money security interest (“PMSI”) is a security interest that arises under the Uniform Commercial Code (“UCC”) in certain circumstances. A PMSI is created in favor of the party who provides a purchaser with the money to purchase goods or software. In such circumstances, the law deems that the party who provided the funds for the purchase will have a security interest in the goods purchased with those funds. The effect of a PMSI can be significant, because the UCC grants the holder of a PMSI the right to seek a return of the collateral, or, if a bankruptcy is filed, the Bankruptcy Code may give the holder of a PMSI priority over other creditors.
A PMSI is created any time goods are not fully paid for by the buyer at the time of delivery. A common example is the installment sale of equipment from a manufacturer to its customer. If the manufacturer agrees to ship a machine upon payment of one-half the purchase price at the time of shipment and the buyer agrees to make monthly payments of the balance over the following months, a PMSI in favor of the manufacturer is created by operation of law. While the PMSI is created automatically, the manufacturer must take certain actions in order to perfect the security interest to ensure that its security interest will have priority over the rights of others – such as the buyer’s lender – who may claim a security interest in the same equipment as a result of loan documents executed by the buyer.
To perfect a PMSI, the manufacturer must file a UCC financing statement within 21 days of the date of delivery of the goods to the buyer. The filing of a financing statement is a relatively straightforward procedure. Once properly filed, the financing statement perfects the manufacturer’s security interest in the goods purchased with the funds provided by the secured party. After filing the financing statement, the manufacturer becomes a secured party.
As a secured party, the manufacturer enjoys certain rights. If the buyer – called the “debtor” under the UCC – fails to make any installment payments to the secured party, the secured party has the right to disable the equipment in place, so long as its actions in doing so can be accomplished without a breach of the peace. Disabled equipment usually results in payment by the debtor who requires operable equipment to conduct its business. Further, the secured party also has the right to seek a court order for the return of the equipment subject to the PMSI.
If the debtor files bankruptcy, the PMSI may provide the secured party with the right to recover the equipment and its proceeds. Further, the secured party may be able to assert that the creation of the PMSI or payments received by the secured party from the debtor in the 90 days prior to the bankruptcy do not qualify as “preference payments” which must be returned to the debtor’s estate as part of the bankruptcy.
Please do not hesitate to telephone us if you have any questions about whether a transaction may have created a PMSI, the perfection of a PMSI, or your rights as a secured party.