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Special Considerations for Purchase-Money Security Interests

Creditors that are looking to obtain a purchase-money security interest (and likewise the priority in purchase-money collateral afforded by a purchase-money security interest) should be aware of some of the pitfalls that can trap creditors.   While the rules pertaining to purchase-money security interests are incredibly complex, there are a few special considerations every creditor should remember.

First, the money loaned must actually be used to purchase the goods or inventory being pledged as purchase-money collateral.  In fact, the best way to prove this is often to have the lender pay the vendor directly on behalf of the debtor.

Second, excluding inventory and livestock, the purchase-money security interest must generally be (1) perfected when the debtor receives possession of the collateral or (2) within twenty days after the debtor receives possession of the collateral.   With respect to inventory, (1) a purchase-money security interest must perfected when the debtor receives possession of the inventory (no twenty day grace period!), (2) the secured party must send an authenticated notification to the holder of the conflicting security interest and the holder of the conflicting security interest must receive this notice within five years before the debtor receives possession of the inventory, and (3) the notice must substantively comply with the statutory requirements.

Third, and in light of the special rules related to inventory in particular, lenders must be certain how the collateral is being used or held by the debtor.  For example, it is possible that “equipment” in the hands of one debtor might be “inventory” in the hands of another.  This is frequently an issue in equipment rental or car dealership industries.  Therefore, lenders should pay particular attention to how the collateral will be utilized to ensure proper perfection.