Alert - Equitable Principles May Override UCC Seemingly Strict Statutory Scheme of Lien Priorities

March 18, 2015

Based on a recent California case (Feresi v. Livery, 2014 Cal.App.LEXIS 1138 (Cal.App.2d Dist. Dec. 15, 2014)), equitable principles may override Uniform Commercial Code (“UCC”) priority rules in situations where a creditor breaches his/her fiduciary duty to another creditor.

In Feresi, pursuant to a dissolution of marriage judgment, Feresi obtained an interest in an LLC.  Feresi’s ex-spouse granted to Feresi a security interest in his remaining LLC interests, which Feresi did not perfect by filing a financing statement.  However, Feresi did notify the LLC’s manager of the security interest in her ex-spouse’s remaining LLC membership interest.

The LLC manager later made an unsecured loan to the ex-spouse and filed a financing statement in order to perfect the LLC manager’s interest in the loan.  When the ex-spouse defaulted on his obligations to Feresi, she succeeded in her foreclosure of his interest and took title to the entirety of her ex-spouse’s interest in the LLC.  The LLC manager later sought to enforce his alleged lien on the ex-spouse’s membership interest now in the hands of Feresi, claiming that his perfected lien was senior to and had priority over Feresi’s unperfected lien.

The LLC manager relied upon the strict interpretation of the UCC’s lien priority rules.  However, the court ruled otherwise.  The court noted that the UCC itself acknowledges that the UCC provisions are to be supplemented by “principles of law and equity.”  The court also found that the LLC manager breached his fiduciary duty to the LLC’s members, and specifically Feresi, to the extent that he attempted to perfect his own security interest ahead of Feresi’s prior security interest.  As a result, the court ruled that Feresi owned all of her ex-spouse’s LLC membership interests free and clear of any liens.

Based on the Feresi decision, practitioners, when evaluating lien priority issues, should be sure to consider the existence of any fiduciary relationships between the parties.  The UCC’s seemingly strict statutory scheme of lien priorities is not as strict as once believed.