The UCC search and filing process can be difficult to understand, with many complexities and jargon to learn. One interest that people who are new to UCC frequently inquire about is purchase money security interests, specifically what they are and how they work.
A purchase money security interest (PMSI) is a type of security interest that allows those who finance a debtor’s acquisition of goods to obtain a priority security interest in the purchase-money collateral, according to UCC Article 9. Even if another creditor has a previously perfected security interest, the PMSI secured party takes precedence.
A PMSI is frequently used by a seller of goods to secure the price and advance funds to allow the debtor to purchase the goods. However, it is important to note that the PMSI secured party’s super-priority is limited to the good that they enabled the debtor to acquire.
What Is a Purchase Money Security Interest?
A “purchase money security interest” (PMSI) is a legal claim that allows a lender to either repossess property financed with its loan or demand cash repayment if the borrower defaults. It gives the lender priority over other creditors’ claims. In layman’s terms, a PSMI grants initial claims on property to entities that finance consumer or other debtor purchases.
Understanding Purchase Money Security Interest
If debtors fail to meet their financial obligations, lenders have several options to protect their financial interests. Consumers who fail to make debt payments may be pursued by financial institutions by sending them to collections, taking legal action, enforcing liens, or obtaining special interests such as purchase money security interests. This interest gives a specific lender a right to property or its full cash value before any other creditor—as long as that lender’s money was used to finance the purchase.
Some commercial lenders and credit card companies, as well as retailers who offer to finance, use a PMSI. It effectively gives them collateral to seize if a borrower fails to make a large purchase on time. In addition, it is used in business-to-business (B2B) transactions. The ability to obtain a PMSI encourages businesses to boost sales by directly financing new equipment or inventory purchases.
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In most jurisdictions, a purchase money security interest is valid once the buyer agrees in writing and the lender files a financing statement. Article 9 of the Uniform Commercial Code (UCC)—the standardized business regulations adopted by most states—describes the purchase money security interest procedure. These regulations were enacted to make it easier for corporations to conduct cross-state business. Article 9 of the code governs the treatment of secured transactions, including the creation and enforcement of security interests.
One reason for the growth of point-of-sale financing, in which a retailer offers buyers direct financing for large purchases; is the protection provided by a PMSI. If the purchaser defaults, the retailer has the right to repossess the items purchased before any other creditors are satisfied.
Purchase Money Security Interest Rules
The PMSI rules differ depending on the type of collateral obtained with loan proceeds. In general, the first creditor who files a financing statement or perfects its security interest in the collateral receives PMSI. The specific rules for inventory and non-inventory collateral are listed below; though there are also rules for other types of goods.
Inventory Collateral PMSI Rules
The rules for perfecting PMSI in inventory are outlined in Section 9-324(b). First, when the borrower takes possession of the inventory, the PMSI must be perfected. Second, before perfection, the secured party must notify conflicting security holders. Third, the secured party must notify other security holders of its intention to acquire a PMSI from the borrower’s inventory.
The secured party must file a UCC-1 that identifies the goods sold as collateral to perfect a purchase money security interest in inventory. This filing informs other interested parties that the secured party is attempting to obtain a PMSI in the borrower’s personal property. Furthermore, the written notice must be delivered to other security notices no more than five years before the borrower receives inventory.
Non-Inventory Collateral PMSI Rules
The rules for obtaining a PMSI for non-inventory collateral are frequently less stringent. The secured party must be able to demonstrate that the borrower’s credit was used to purchase the collateral. Within 20 days of the borrower receiving possession of the collateral; the secured party must also file a financing statement covering the collateral.
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A secured party must file a UCC-1, similar to an inventory purchase money security interest, to perfect a PMSI for non-inventory collateral. This must be filed either before or within the first 20 days of the borrower’s possession of the collateral. If the filing occurs after the 20 days, the secured party will not have PMSI priority and will be prioritized after other perfected security interests.
How Do I Get a Purchase Money Security Interest?
A PMSI is obtained when a creditor lends money to a borrower, who then spends the money on goods. In exchange, the borrower grants the creditor a security interest in the goods if they default on their loan.
Different types of collateral or goods have different rules, but the secured party must file a UCC-1 to publicly communicate their intention to gain a secured interest in a good. Other potential secured parties may also be required to be notified by the secured party.
What Is a Purchase Money Security Interest UCC?
A PMSI is an exception to the first-in-time creditor prioritization rule under the Uniform Commercial Code. According to the UCC purchase money security interest, creditor priority for secured interests is frequently determined by who was the first secured creditor (or the timing of when their interest occurred). The PMSI exception allows creditors who were not the first to file to still secure an interest in the collateral.
Example of a Purchase Money Security Interest
Let’s look at a hypothetical case to see how a purchase money security interest works in terms of prioritizing secured parties. In this example, the first secured party filed a UCC on all assets in 2010. The equipment was then secured by another secured party, who filed a UCC on it a year later. So, another secured party filed a purchase money security interest UCC on a laser wigit model 1234 a year later.
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Secured party 3 has the highest priority in this case because they filed on a specific machine; which means their debt will be paid first. Secured party 1, which was established in 2010, would have priority over all other assets, including equipment. SP2 is most likely out of luck because the older asset claim (including equipment) takes precedence.
Special Considerations
At the heart of PMSI, the party seeking the secured interest must show that the credit extended was used to acquire the collateral. As a result, a company may want to purposefully structure a payment sequence or series of contracts for goods; that have not yet been manufactured.
For example, if a consumer agreed to buy a custom-made sofa from a furniture retailer on credit; the retailer would place an order with the manufacturer and pay for the sofa before finalizing the financing agreement. In this case, the retailer owns the sofa being sold, not the manufacturer. In legal terms, the retailer has a security interest in the property that was just sold and can obtain and enforce a purchase money security interest.
For the same reason, if the buyer places a security deposit on the sofa; the retailer may require the buyer to pay for it in full before returning the security deposit. This establishes the full dollar amount that the lender has the right to demand in the event of a default. Court decisions on PMSI claims have established the lender’s right to seek reimbursement for other costs associated with the purchase; such as freight and sales taxes.
Conclusion
Priority order can determine whether or not a loan debt is repaid. Creditors with priority have a better chance of collecting against a debtor than those who file late or fail to secure their claim at all.
A creditor with a purchase money security interest, on the other hand, can gain priority over previously perfected security interests if they meet UCC Article 9 criteria.
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PMSI is a useful tool for lenders who want to assist with financing a specific purchase. This scenario is advantageous to all parties involved:
- The existing lender with priority benefits from the debtor’s ability to obtain additional funds to acquire inventory or equipment necessary for the debtor’s operations. This existing lender (in the preceding example, a big bank) would not otherwise have the first position on the underlying collateral. The debtor would not be able to purchase that collateral without the PMSI lender.
- The PMSI lender wins because the loan is made, and the underlying assets are given priority. (It’s not uncommon for alternative lenders to have higher interest rates here.)
- The debtor benefits from the ability to finance the assets.
- Purchase Money Security Interest under UCC
Frequently Asked Questions
Is a security interest a PMSI?
A purchase money security interest (PMSI) is a security interest granted to someone who helps another person acquire personal property. A lender, lessor, consignor, or supplier may be the person who facilitates the acquisition.
How do you perfect a purchase money security interest?
Complete the PMSI by filing a financing statement naming the borrower as debtor and the seller as secured party, as well as correctly identifying the goods to be sold as collateral. To identify the borrower’s secured creditors and their collateral, conduct a UCC search in the appropriate jurisdiction.
What is a non-purchase money security interest?
A security interest in property that the debtor already owns and is used as collateral for a loan. This type of lien can be discharged in a bankruptcy proceeding.
What is a PMSI Ontario?
Section 1(1) of the Ontario Personal Property Security Act (PPSA) defines a PMSI as one of the following: a security interest taken or reserved in collateral other than investment property to secure payment of all or part of its price.
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