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Is Your After-Acquired Property Clause What You Think It Is?

The “after-acquired property clause” has become a staple of security agreements and wisely so. Without inclusion of such a clause in the granting language of a security agreement, some courts have held that a security interest does not extend to after-acquired property. Unwilling to take any risk and as a best practice, secured lenders have built after-acquired property clauses into their security agreements. Commonly, secured lenders have used the language “whether now owned or hereafter acquired” or a close variant thereof and have felt secure that such language fully protects their interest in after-acquired property. A closer look at the Uniform Commercial Code (the “UCC”), though, reveals that this widely used phrase unnecessarily shrinks the scope of the secured lender’s collateral.

Section 9-203(b)(2) of the UCC sets forth what rights a debtor must have in collateral in order for it to grant a security interest in such property. The section states that a debtor may grant a security interest in any collateral so long as the debtor “has rights in the collateral or the power to transfer rights in the collateral”. Importantly, the UCC does not require that the debtor have full ownership of or legal title to collateral in order for such debtor to grant a security interest in such collateral. Rather, the debtor must merely have rights or the power to transfer rights in the collateral. The distinction is important because there are instances in which a debtor may not own collateral but may otherwise have rights in such property, such as in the context of consignments, bailments and leases.

Since the UCC does not require that a debtor own collateral, an after-acquired property clause shouldn’t be tied to ownership since it needlessly carves out a slice of potential collateral. The case In re Salander-O’Reilly Galleries, LLC, 2014 WL 7389901 (S.D.N.Y. Nov. 25, 2014) highlights this very point. In In re Salander-O’Reilly, Kraken Investments Limited (the “Consigner”) consigned a $9.5 million Botticelli painting to Salander-O’Reilly Galleries, LLC (the “Art Gallery”), an art gallery in New York City.  The Art Gallery filed for bankruptcy and a dispute arose over who had superior rights to the Botticelli: the Consigner or the Art Gallery’s secured lender (the “Bank”).

The Art Gallery had granted the Bank a security interest in all personal property of the Art Gallery “whether now owned or hereafter acquired”. Although the loan agreement seemingly covered all personal property, the court reasoned that by including the clause “whether now owned or hereafter acquired”, the security interest was limited to that personal property which was actually owned by the Art Gallery.  In this case, it was undisputed that the Consigner was the owner of the Botticelli. Thus, the Bank had not been granted a security interest in the Botticelli due to the Art Gallery’s lack of ownership interest in the painting. Had the language of the after-acquired property clause tracked the broader language contained in U.C.C. § 9-203(b)(2), the Botticelli would have been subject to the Bank’s security interest.

Although the use of the after-acquired property clause in In re Salander-O’Reilly worked against the secured lender in such case, it’s important to emphasize that the existence of the after-acquired property clause in the security agreement wasn’t the issue. Rather, it was the wording of the clause. As a result, at least with respect to the use in security agreements, secured creditors shouldn’t remove the after-acquired property clause altogether. Instead, the secured lender should ensure that the language of the after-acquired property clause isn’t tied to ownership or title but rather that which mirrors the language used in § 9-203(b)(2).

If you are entering into a secured transaction or are undertaking a review of your existing loan documents, please contact us to ensure the language of your after-acquired property clause captures the full scope of your intended collateral.