As a professional athlete, sooner or later you will be approached by an individual (like a family member or friend) or business with a request to borrow money. It's almost inevitable, especially when the media regularly publishes your earnings for all to see. As such, lending may very well become one of several investment options for you.
When lending transactions are structured properly, having a fixed-income security, such as a promissory note from a small business or a tax-exempt bond from a city, state or hospital, can provide you with a consistent and predictable stream of cash flow over a specific term. When not done properly, you can lose the principal (i.e., the amount you loaned), all your future interest payments and rights to any collateral.
So when you're thinking about lending to a friend, family member or business owner, one way to make sure you see your money again, or at least part of it, is by properly structuring a secured transaction (i.e., a loan or purchase that is secured with collateral), which will give you the right to take possession of any collateral when the borrower fails to pay. As part of this secured transaction process, you may be required to file a financing statement, so knowing what a financing statement is and how it is used is important for protecting your finances.
What is a financing statement?
In order to have a good understanding of financing statements, you'll need to first have a handle on another secured transaction term: perfection.
When you obtain a security interest (i.e., a claim to assets that have been pledged as collateral for a loan) through a security agreement signed by a debtor/borrower, you will need to "perfect" that security interest to help protect your security interest.
Perfection is a way to give other potential lenders/creditors notice that you already have a claim to those assets being pledged as collateral. When a specific asset has been pledged to multiple creditors, perfection of a security interest obtained before those other creditors will allow you to have a priority claim to those assets.
Example: Let's say you lend a friend $10,000.00 to buy gym equipment, and through a security agreement, you receive a security interest in that equipment that allows you to take possession of the equipment upon failure to make payments and resell it to get some of your cash back.
Three weeks later, and without notice to you, your friend borrows $5,000.00 from a bank and uses the gym equipment as collateral. In this situation, your friend has pledged gym equipment worth $10,000.00 for loans in the amount of $15,000.00. That's trouble.
As you can guess, if that friend can't make payments on the loans and triggers rights of repossession on the gym equipment, you or the bank may be coming up short in getting your money back.
One way to protect yourself and your security interest in collateral is by perfecting it before other creditors do.
While there are several ways to perfect your security interest, one way (and in some instances, the only way) is to file a financing statement with the appropriate state office responsible for administering the Uniform Commercial Code (UCC) database. For example, in Washington, the Department of Licensing is responsible, whereas in Texas, it is the Office of the Secretary of State. Your own state may be a totally different office.
A financing statement is a document filed with a public office that puts other potential and/or current creditors on notice of a secured party's security interest in collateral. Depending on the date and time of when you file, you may have priority on claiming assets before other creditors.
Example: Using our gym equipment example above, let's say you properly file your financing statement before the bank. Upon default of loan payments by, your friend will be able to satisfy its outstanding debt with you first. So if the gym equipment is only worth $9,500.00, you'll be able to take custody of the gym equipment, sell it and get back $9,500.00 of your original $10,000. The bank, on the other hand, will come up short, and suffer the consequences of not checking to see if the gym equipment was already being used as collateral.
While the required information in a financing statement can vary from state to state, the most common pieces of information are:
the exact name of the debtor(s),
the exact name of the secured party(ies), and
an indication of collateral.
To make the financing statement research process easy for creditors, most states use the standard Form UCC-1, which can be seen below:
The dates on these filings will help determine which creditor has priority claim to collateral. In some instances, creditors will file financing statements in advance of obtaining a security interest (e.g., before signing a security agreement) to make sure it has a date on file that is earlier than other parties. This tactic may be common when a borrower is shopping lenders, and the borrower may use multiple creditors to fulfill its financing needs. Note: You always want to be the first to perfect your security interest.
Knowing what a financing statement can also be helpful when you are doing your due diligence before lending to someone. Simply find out who the borrower will be and look them up in the appropriate UCC database to see if they've pledged assets that they may also be pledging to you to another creditor. If so, you may reconsider changing the type of asset to be used as collateral or declining the loan altogether.
Example: If you'll look back to the gym equipment example, a bank that is lending responsibly will check the UCC records to see if the gym equipment is being pledged elsewhere before loaning additional funds secured by that equipment. If you've properly filed your financing statement, the bank will see the gym equipment is pledged and either decline the loan application or require additional collateral.
Each state has different rules on how to properly file and complete financing statements, so if you are obtaining a security agreement, and a security interest in collateral, you'll want to talk to an attorney to help make sure your financing statement, if required, is properly and timely filed, or determine what assets have already been pledged by a potential borrower.
Chris McCauley, CPA, Esq. is the founder of McCauley Investment Risk & Legal Consulting PLLC, a Seattle-based law firm dedicated to helping professional athletes guard their earnings and investments. Chris is an attorney licensed to practice in Alabama and Washington and a CPA licensed to practice in Washington and North Carolina.