Lien Priority and an Altered Credit File
Harbor Point Logistics has requested a $950,000 increase to its $2.1 million credit line. A UCC search shows a competitor, Coastline Capital, filed a blanket UCC-1 two years ago covering all assets. Harbor Point's CFO says Coastline will sign a subordination agreement next week and urges you to fund now and file your own UCC-1 first, arguing that first to file wins. The customer supplies a personal financial statement marked for discussion only and asks that it not be shared with your credit committee. While reviewing the file, you learn that a junior analyst changed the accounts payable aging to make a 95-day past-due balance appear current. The sales director says the change is immaterial because the customer is basically current and the deal is important. Your company's policy requires a lien search, verified financials, and written approval before funding any secured facility. The customer is also 40 days past due on $180,000 of existing invoices.
1. Explain the UCC priority issue. Will filing a new UCC-1 ahead of Coastline's agreement give your company first priority? What must happen before funding?
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Filing a new UCC-1 does not defeat Coastline's earlier filing. Under UCC Article 9, priority between competing security interests in the same collateral generally follows the first-to-file-or-perfect rule. Coastline perfected two years ago; a later filing is junior, even if it is filed before a subordination agreement is signed. First to file wins is true only as between filings, not as a way to leapfrog an existing perfected lien. Before funding, obtain a written subordination or intercreditor agreement from Coastline, or a payoff and termination statement. If the new loan is a purchase-money security interest in specific equipment, it may have priority if filed within 20 days after the debtor receives possession; for inventory, a PMSI requires filing before the debtor receives possession and authenticated notice to Coastline. A security agreement and authorization are also required. Do not fund on a promise of next week.
2. Identify the ethical and internal-control problems in the file and state how the credit manager should respond.
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The altered AP aging is falsification of credit records, not an immaterial adjustment. The credit manager must preserve the original, restore the accurate aging, report the change to internal audit or compliance, and disclose it to the credit committee. The analyst should not be allowed to influence the file further. The for discussion only personal financial statement cannot be used as the basis for approval while being withheld from approvers; the credit manager should tell the customer that material financial information must be available to the decision-makers, or the application cannot proceed. Sales pressure and the customer's importance do not override accuracy. The existing $180,000 delinquency is also material and must be addressed before any increase. Document the sequence of events and the disclosures.
3. Recommend a course of action: decline, approve with conditions, or restructure. Include legal documentation and monitoring.
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Recommend no new funding now. Conditions for reconsideration: (1) existing $180,000 past due brought current; (2) written, executed subordination or intercreditor agreement from Coastline, or payoff and termination; (3) verified financial statements and a personal financial statement that may be shared with the credit committee; (4) a new UCC-1 and security agreement, junior if subordination is used; (5) a personal guarantee; (6) independent lien and tax search; (7) a borrowing base and cash dominion if inventory or receivables are collateral. The credit manager should also disclose the altered document and recuse anyone involved in it. If the subordination is not delivered, decline the increase. The ethical and legal exposure from proceeding on a false record and a junior lien is greater than the sales opportunity.