Previously, we have discussed the high-level issues of either acquiring or selling a business, in a blog article entitled, The Art of Buying and Selling a Business. In this article, we discuss the all-important requirement of conducting a UCC Search and Lien Search as part of your due diligence before purchasing a business.
BUYING A BUSINESS
When buying a business, there are usually four (4) steps: Finding the right business, negotiating, due diligence and closing. Each step is very important and when deals fall apart it’s usually because the acquirer attempts to skip one or more steps. Buying a business is usually a huge investment and any potential owner wants to be sure about what they’re getting into. Even if you think you know the business and its inner workings, conducting a UCC search and Lien search should be considered a critical aspect of the due diligence phase.
WHAT IS A UCC SEARCH & LIEN SEARCH?
Often, businesses will pledge certain assets as collateral for lines of credit, loans and other financial products. Such assets can include just about anything, such as certain intellectual property, the goodwill of the business, fixtures, inventory, accounts receivable, bank accounts and more. When a business does this, the creditor will file a UCC-1 financing statement with the Secretary of State where the business is lawfully registered.
The “Uniform Commercial Code” (or UCC) is a series of commercial legal rules that have been standardized among most states. Through a UCC-1 financing statement, creditors can give notice to the public that they have (or may have) an interest in the property of a debtor (the business). When this notice is properly given (i.e. filing with the Secretary of State or appropriate governmental agency), the party giving notice will (usually) have superior rights over any other third-party that attempts to claim an interest in the same property. Such other third-parties can include subsequent debtors or even innocent third-party purchasers.
Therefore, a UCC search is the process whereby you go to the proper Secretary of State’s office, and search its UCC records for the name (or names) of the seller, to ensure neither the seller nor the company are the subject of any UCC-1 financing statements.
A lien search is very similar to a UCC search, except the search is at the county where a particular business (or real property) is actually located within a state.
WHY SHOULD YOU CARE ABOUT A UCC SEARCH AND LIEN SEARCH?
For illustration purposes, consider buying a home. You search and search until you find the right one. It’s a daunting process. Once you find a potential home, you research it in-depth. You look at neighborhood information, remodels and similar homes to make sure you are paying the right price for a home you’ll love. Just as you’re getting ready to sign on the so-called ‘dotted line’, you find out that the fixtures in the house have already been promised to someone else! Will that kill the deal for you? Maybe…but you’ll certainly want the change in circumstances to be reflected in the price you pay. The same issues apply when buying a business.
Would you buy a business without knowing all the information?
When a properly filed UCC-1 financing statement (or properly filed lien) exists, the creditor giving notice will have the legal right to collect the property it has an interest in before anyone else that comes later. Therefore, the date is critical and if one is considering buying the assets of a business, the proverbial “buyer beware” is apt. The law assumes the acquirer has conducted a proper UCC and lien search to ensure they are not attempting to purchase assets that someone else already maintains a valid claim or interest in.
When one buys a business, the value in a business is generally tied to the assets. Therefore, if one doesn’t conduct a UCC search or lien search, that individual can be potentially purchasing a business whose assets could subsequently be taken by another party.
UCC FILINGS AND LIENS ARE MORE COMMON THAN YOU THINK
Just because a business owner says he has paid off a particular debt, doesn’t mean the UCC-1 financing statement or lien has been removed. Furthermore, some businesses or business owners can neglect some of their taxes (income, sales, gross receipts or license fees) and the appropriate taxing authority will slap a lien on all the assets of a business, without the owner’s knowledge and even though that business continues to operate as though nothing has happened.
When it comes to acquiring a business, we recommend the following as it relates to a UCC search and Lien search:
- Conduct a UCC search on the owner (or owners) themselves, as well as the actual name of the business.
- Similarly, conduct a lien search at the county level for the owner or owners, themselves, as well as the actual name of the business.
- The specific county or counties to search can be tricky. Follow these general guidelines:
- Any and all counties where real property is located, if real property is a part of the deal.
- The county where the “physical address” of the company is listed, in the state registration for the corporate entity.
- Any and all counties that serve as the primary residences of the owners. Don’t forget to account for owners moving from one county to another. If they have changed primary residences within a time period you feel relevant (usually within 5 years), consider conducting a search in the county (or counties) of their former primary residences, as well.
- Beware of too large a time difference between the closing date and your UCC search and lien search. Don’t let a lien or UCC financing statement creep in between due diligence and closing.
- Don’t rely on seller affirmations or promises. There could be liens they are not aware of.
- As mentioned previously, just because a seller paid off a previous debt, doesn’t mean the the UCC financing statement or lien has been removed.
- If there are any UCC financing statements or liens on any assets being acquired, make sure they are removed prior to the closing, or escrow funds as appropriate to cover the assets subject to the UCC financing statement or lien.
As with any important business decision, don’t forget to include a good business attorney, CPA and banker as part of your acquisition team. This is not the time to try and save money — as a wrong move could jeopardize your entire investment and even more.
Law 4 Small Business. A little law now can save a lot later.