The Spearing Tool Filing System Disaster
Lynn M. LoPucki
University of California, Los Angeles (UCLA) - School of Law
UCLA School of Law, Law-Econ Research Paper No. 06-10
Debtor name errors have been a substantial and persistent problem for filers and searchers in the Uniform Commercial Code Article 9 filing system. Filers make errors in spelling, punctuation, and spacing, use trade names, and include extraneous words. The law prior to 2001 excused such errors if they were minor and not seriously misleading. That put the burden on searchers to conduct reasonable diligent searches to find erroneous filings. The effect was to render all searches problematic and costly.
The drafters of revised Article 9 conceived a brilliant solution to the problem with respect to corporate debtors (registered entities). First, they required filers to file in the exact, correct names of their debtors, forgiving only errors that would be caught by the filing office's official search logic. That meant a searcher could conduct a single search in the exact, correct name of a debtor and be assured of finding every effective filing. To make exact, correct names easily available to filers and searchers, the drafters changed the place for filing against a corporate debtor to its state of incorporation. Because the same office would have both the Article 9 and corporate record for a debtor, filing officers could set up point and shoot systems in which filers and searchers selected their debtors from the list of all entities incorporated in the state rather than attempting to name them. Had point and shoot been implemented, filing or searching against the wrong debtor would have remained possible, but debtor name errors would have been eliminated completely.
The Sixth Circuit's decision in Spearing Tool nullified the drafters' efforts. The court held federal tax lien filings valid despite the Internal Revenue Service's failure to comply with the exact, correct name requirement. Because nearly every searcher is concerned with tax lien filings and those filings are in the Article 9 filing system in nearly all states, the practical effect of the decision was to reinstate the reasonable diligent search requirement for Article 9 searching.
This essay applies systems analysis to demonstrate that the Spearing Tool decision imposes six kinds of costs on lenders while providing no significant benefit to the Internal Revenue Service: the costs of (1) name variation searches, (2) receiving and acting on notices of name variation, (3) purchasing insurance against search failures, (4) subordination of loans as a result of search failure, (5) litigating the reasonableness of search methods, and (6) professional advice on how to respond to Spearing Tool in specific circumstances.
Despite the increase in total system cost resulting from Spearing Tool, reversal of the decision is highly unlikely. The IRS can prevent relitigation of the issue until the operation of the system has adjusted to the point where the cost of reversal would be prohibitive. Reform requires coordinated state and federal legislation.
Number of Pages in PDF File: 35
Keywords: Uniform Commercial Code, Article 9, filing system, tax liens, UCC search, Article 9 search
JEL Classification: K12, K22, K29working papers series
Date posted: March 13, 2006
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