1. Representing the Asset-Based Financial Services & Factoring Industries Worldwide April 09
Demand for Factoring High,
But Challenges Still Exist
Participations: Traditional
Factors Discuss Current
Credit Environment
Interview with Peter Rosenthal:
Factoring is in His Blood
the face
of factoring

2. Practical Strategy for Improved Risk Management
Article 9 Collateral Insurance Shifts Risk for
Secured Lenders
By theodore h. sprink
The nation’s most respect- Frozen credit markets, residential foreclosures, government bailouts of the private sector, Fed Funds rates not
seen since the 1930s, the questioning of the SEC and the rating agencies, stock market setbacks, unstable ener-
e d f i n an c ia l re porte rs , gy prices, interest rates, cap rates, the fear of inflation, deflation, stagflation, recession, depression, increases in
business bankruptcy filings, higher unemployment rates, reduced orders for manufactured goods and slipping
economists and market ana- consumer confidence: these are just some of the issues that suggest commercial-loan default rates may play a
lysts have m a d e
more significant role in bank strategies than they have in the past. In recent years the stable economy
has “masked” commercial-loan defects,
today’s reces-
not linking them directly to defaults,
loss-given-default and loan recoveries.
Documentation defects that will directly
sion and federal affect value and recoverability of col-
lateral have been kept somewhat below
bailouts seem very the surface because many of the affect-
ed loans are not yet in monetary default.
complicated. However, to And, in the past, a good loan work-out
effort, coupled with alternative sources
many, devastating econom-
of capital, could move a defaulted bor-
rower out of the bank. No more.
The existence of technical defaults,
ic developments particularly repeatedly renewed “PIK” loans, and
a swelling emergence of monetary
as experienced in the third defaults suggest a strong likelihood that
many borrowers are headed toward
and fourth
insolvency proceedings. This potential is
increasing dramatically each month and
quarters
is likely to result in frequent challenges
to commercial lenders’ security interests
as competing parties focus on collateral
of 2008 are in order to maximize their recoveries.
a rather Today’s Business of Banking: Little
Room for Error
simple
Perceived equity cushions, a stable
economic environment and plentiful
story of
alternative sources of capital have for
years artificially hidden problems as-
sociated with collateral value, borrower
risk man- cash flow and management difficulties.
Loan concentration, relaxed underwrit-
agement ing standards, declining asset values
and increasing defaults in core lending
and cred-
it quality.
46 Visit the CFA CAreer Center At www.CFA.Com. the seCured lender April 2009 47

3. segments are causing lenders to seek Document on Operational Risk stated: standards (and loan covenants), regula- basis. Additionally, UCC insurance was
risk-management tools that protect “One growing risk of mitigation tech- tors can be expected to call for improved developed to protect commercial lend-
credit quality and liquidity. nique is the use of insurance to cover identification and management of risk. ers against fraud, forgery, documenta-
ThroughouT The laTe 1990s and 2000s The Throughout the late 1990s and 2000s certain operational risk exposures.” Risk Both lenders and investors benefit from tion defects, search-office errors and
markeT was awash in liquidiTy wiTh far the market was awash in liquidity with managers have used title insurance to strengthened collateral positions and omissions and indexing problems in the
“Too much money chasing Too few deals.” far “too much money chasing too few shift risk in past real estate transac- the shifting of risk as it relates to lien financing statement search and filing
PerhaPs, iT could be said, Too few well- deals.” Perhaps, it could be said, too few tions, in what has become an essential perfection and priority. process.
sTrucTured deals exisTed well-structured deals existed: hedge component of the real estate-secured The title industry has essentially Further, UCC insurance was designed
funds and private equity partnerships in loan-origination business. adapted the standard ALTA real estate to insure the “lending gap” and provide
competition with, or financed by banks, title-insurance policy form to provide cost-of-defense coverage in the event of
were deploying vast sums of money Traditional Shifting of Risk the benefits of title insurance to com- a third-party challenge to the lender’s
from pension plans, endowment funds Traditionally, real estate lenders for both mercial lenders securing loans with security interest and lien priority. From
and foreign investors. In the wake of this commercial and residential transac- non–real estate collateral. In a few short a secondary-market perspective and
competition, relaxed covenant packages tions, as well as investors, have used years the nation’s leading title insurers portfolio-management standpoint, the
and historically low-risk pricing, there title insurance to minimize documenta- have produced new UCC insurance poli- policies are “life-of-loan” and assignable.
has been very little room for error. tion errors and to perform processes cies covering an estimated $450 billion
Such relaxed standards have had a associated with perfecting lien priority. in secured lending. Avoiding the Most Obvious and
significant impact on credit quality, loan Lenders and investors have utilized title Most Common Risk
loss reserves, regulatory capital require- insurance to benefit from improved The Evolution of Title Insurance As a significant benefit to the lender,
ments, loan pricing, reliance collateral, credit quality, secondary market value Historically, real estate title insurance UCC insurance overcomes limited “UCC
default rates, potential legal fees and, and liquidity. played an important role in loan origina- search vendor” indemnification in con-
ultimately, recoveries. As late as the mid-1950s, real estate tions by insuring proper perfection and nection with search office errors and
title insurance had not yet become uni- priority of collateral and by protecting omissions, indexing inconsistencies and
Connecting the Dots versally accepted or utilized by lenders. lenders from fraud, forgery and docu- financing-statement inaccuracies. Most
The broadening of the recession is re- Lawyers’ legal opinions and abstracts mentation defects. UCC insurance for commercial-loan documentation defects
flected by connecting the dots from sub- were widely used in the nation’s real es- non–real estate collateral is the natural that jeopardize a lender’s security
prime and Alt-A loans, generally viewed tate markets. Standardized real-property evolution of this concept in light of the interest are clerical in nature: incorrect
as entirely toxic, to traditional residen- title-policy forms of coverage, endorsed growing need to protect and enhance name of borrower, search of the wrong
tial real estate loans, now suffering from by the American Land Title Associa- the strength and quality of commercial- jurisdiction, wrong state of filing, the
plummeting values and skyrocketing tion (ALTA), were still a decade away. loan assets. lack of filing the appropriate documents,
default rates; to commercial real estate Although title insurance developed into The original concept of applying the an error in the collateral description and
loans, due to suffer significantly from a cornerstone of traditional real estate benefits of real estate title insurance to the like. Moreover, it is often junior staff
cap-rate and occupancy issues; to the lending, a new concept of title insurance the commercial finance market segment at either the bank or the law firm that is
commercial finance asset-based lending has evolved over the last few years into was simple: if every bank in the United responsible for perhaps the greatest risk
market, anticipated to be a final resting an accepted risk-management tool for States originating real estate–secured to the lender: the loss of reliance collat-
ground for the defaults, collateral con- secured lenders primarily within the loans requires real estate title insurance, eral. Without UCC insurance, a lender’s ucc insurance, available from The
tests, bankruptcies and other economic private equity space. would those lenders originating non– recourse to an inaccurate search or filing naTion’s leading real esTaTe TiTle-
ills generally associated with recession. However, there is one significant dif- real estate secured loans not also gain function from leading search and filing insurance comPanies, is a relaTively new
These ills will likely result in increased ference: title insurance is now available from the risk-shifting and protection vendors is limited to the cost of the develoPmenT in The financial markeTs.
loan defaults, which will cause greater to lenders in which “reliance collateral” benefits of title insurance? service rendered by the vendor—$100,
reliance on collateral, credit quality and is personal property as defined by Article UCC insurance, available from the na- for example.
risk-management tools. 9 of the Uniform Commercial Code. Such tion’s leading real estate title-insurance
Exposure to operational risk for title insurance for non–real estate loans companies, is a relatively new develop- Benefits of UCC Insurance as a
commercial lenders has also escalated has been recently been positioned by ment in the financial markets. Similar Risk-Management Tool
substantially and has made many insti- one major title insurance underwriter as in many respects to traditional real Risk management is, of course, every-
tutions more vulnerable to losses from a risk-management tool. estate title insurance, UCC insurance one’s business within a bank. However,
failed or inadequate internal processes, was introduced specifically to insure the risk managers are specifically charged
people and systems. From the perspec- New Risk-Management Tools for a commercial lender’s security interest in with the responsibility to anticipate,
tive of risk managers, shareholders and New Regulatory Environment non–real estate collateral for validity, identify, quantify and manage risk
regulatory authorities, the consequenc- With regulatory authorities subject to enforceability, attachment, perfection across each of their increasingly compli-
es of such failures are severe. criticism for allowing an excess con- and priority. cated portfolios of businesses.
That’s why title insurance has become centration of subprime and Alt-A loans Policies include UCC search and Positive economic conditions in
more important. The Basel Committee within certain financial institutions, filing services, are life-of-loan, and are recent years appear to have led lenders
on Banking Supervision’s Consultative coupled with relaxed underwriting frequently issued on a postclosing to fail to “price-to-risk,” particularly
48 Visit the CFA CAreer Center At www.CFA.Com. the seCured lender April 2009 49

4. the legal risks associated with equity ance was developed specifically to fice buildings, manufacturing concerns, be defective in documentation were not
and other personal-property collateral. insure the lender’s security interest in retail operations, power plants, casinos, an issue until they were in (monetary)
However, in a complex and threatening non–real estate collateral, rather than hospitals and the like. default. Naturally, by then, it is often too
environment, evidenced by the recent the ownership or chain of title of real Now lenders could outsource UCC late — for our homes as well as the for
eruption of subprime-related credit- property. Significantly, the program was searches, document preparation and the lender’s collateral position. The $100
quality and liquidity issues, hazards in development during a time of change filing functions while wrapping the indemnity furnished by the bank’s UCC
to the bank’s capital are substantially and uncertainty for the commercial entire transaction in an insurance policy search vendor, or the right to sue out-
elevated. UCC insurance imposes a finance industry. Revisions to Article 9 offered by Fortune 500 insurance com- side counsel, do not represent attractive
discipline and provides an insurance of the Uniform Commercial Code were panies, effectively shifting risk for the alternatives to insured perfection and
product that can significantly reduce looming, scheduled to become effective proper attachment, perfection and prior- priority to the lender’s risk-management
these legal risks. in most states in July 2001. The substan- ity of their security interests in non–real team.
Considering the high level of both tial revisions represented uncertainty estate collateral.
loan-origination and merger and and risk to lenders and their outside The Case for UCC Insurance
acquisition activity in recent years, the counsel in the granting, perfecting and UCC Insurance Broadens Because most banks have grown
opportunities for both human error and enforcing of their security interests. Protection for Secured Lenders through mergers and acquisitions, there
statistical risk modeling that is ineffec- There was also significant concern on UCC insurance would complement, if not is little consistency in commercial-loan
tive in abnormal economic circumstanc- the part of lenders and law firms with replace, the costly, traditional, lender-re- underwriting standards. Market re-
es pose significant undiagnosed danger respect to compliance with the five- quired legal opinion crafted by borrow- search in the early days of the develop-
to loan portfolios and the integrity of year transition rules of Revised Article ers’ counsel with respect to perfection ment of the concept of UCC insurance
the documentation of their underlying 9. Non–real estate assets are defined and priority and provide cost-of-defense found that up to 40% of loans reviewed
collateral. by Article 9 of the Uniform Commercial in the event something went wrong. were subject to some type of documen-
Risk managers are now able to shift Code and often referred to as “per- With regard to high-risk, low-billable tation defect that could result in the
risk managers are now able To shifT commercial-loan risk associated with sonal property” or “Article 9 collateral.” documentation matters, outside counsel lender’s security interest being set aside.
commercial-loan risk associaTed wiTh The the broadening of the current consumer Personal property includes inventory, would be able to focus more appro- But, all so frequently in recent years,
broadening of The currenT consumer and and residential-loan quality “meltdown” furniture, fixtures, equipment, accounts priately on negotiating and drafting the loans were either not in default
residenTial-loan qualiTy “melTdown” by by utilizing a basic, traditional solution: receivable, deposit accounts, general primary loan documents, letting the UCC (yet) or were in some manner adjusted
uTilizing a basic, TradiTional soluTion: “Time Tested Title Insurance: No Longer intangibles, securities and pledges insurers worry about UCC matters. The to reflect a satisfactory internal rating,
“Time TesTed TiTle insurance: no longer Just for Real Estate.” (often crucial to the mezzanine loan insurance coverage would also relieve notwithstanding the potential for the
JusT for real esTaTe.” transaction). A general angst in the liability to outside counsel in connection borrower to head toward insolvency. It
Underwriting, Insuring and marketplace over the possible loss of to priority and perfection issues. is in an insolvency proceeding that often
Protecting Lien Perfection and priority in collateral virtually called out There were those who believed results in a challenge to the lender’s se-
Clear Title for a shift in risk — the core function of that replacing the (multijurisdictional) curity interest, either by the Bankruptcy
Many believe it is the secondary market, an insurance company and the basis for opinion with actual (national) insurance Trustee, the Creditor’s Committee or
evidenced by the advent of Fannie Mae which UCC insurance protection would coverage would serve to reduce risk to even the borrower.
and Freddie Mac and their crucial roles be positioned. the law firms and, by extension, perhaps Recent cases recognized by the title
in the American economy, that led to not one day to reduce malpractice-coverage industry as publicly adjudicated illus-
like all insurance ProducTs, PerhaPs ucc
only the importance of title insurance The Development of UCC Insurance premiums. trate lenders’ exposure from relying on
insurance could be viewed as similar To
for residential (retail) transactions, but Being introduced by the title industry search vendors and/or outside counsel
The fire insurance we all Purchase for
the investment community’s need for and served by a number of major, na- Value of Shifting Risk to ensure proper attachment, perfec-
our Personal homes: you don’T really need
enhanced, high-quality, real estate–relat- tional underwriters providing insurance Like all insurance products, perhaps UCC tion and priority of security interests
The fire insurance unTil The house caTches
ed (wholesale) asset- backed securities. coverage to an industry requiring title insurance could be viewed as similar to in personal property. For example, the
on fire. in oTher words, There is unlikely
This quality enhancement was pro- insurance for essentially every real the fire insurance we all purchase for failure to file a UCC-1 Financing state-
To be a challenge To The lender’s securiTy
vided by the nation’s title industry and estate secured transaction, provided a our personal homes: you don’t really ment by outside counsel led to a legal
inTeresT, unless There is a defaulT.
based on the industry’s ability to deliver, unique opportunity to take advantage of need the fire insurance until the house malpractice judgment against a law firm
insure and defend “clear title.” Although existing sales, marketing and distribu- catches on fire. In other words, there is in an action brought by the client, in
UCC insurance is a relative newcomer to tion channels. For the first time, the title unlikely to be a challenge to the lender’s Kory vs. Parsoff, 745 NY S. 2d 218 (2002).
the financial markets, lenders and inves- industry would be able to insure “both security interest, unless there is a An incorrect/ambiguous financing
tors are poised to gain many of the same sides” of a mixed-collateral transac- default. However, unlike the fire at your statement limited the collateral subject
benefits currently and prominently tion: those deals secured by both real home (that may not result in a total loss to a bank’s filing in Shelby County State
enjoyed in the real estate markets. property and personal property. Thus, a of contents), when a perfection or prior- Bank vs. Van Diest Supply 303 F. 3d 7th
broadening of coverages was available ity defect occurs, it is often catastrophic Cir (2002). In another example, a UCC
Change, Uncertainty and Risk to lenders already familiar with title to the lender in that it consumes all search vendor’s liability for damages
Similar in many respects to traditional insurance in transactions involving the collateral. was limited to $25 for the failure/inaccu-
real estate title insurance, UCC insur- financing of hotels, shopping centers, of- So, even loans known by the lender to racy of the vendor’s search in identifying
50 Visit the CFA CAreer Center At www.CFA.Com. the seCured lender April 2009 51

5. prior liens in Puget Sound Financial, LLC quality utilizing UCC insurance, which
vs. Unisearch, Inc. 146 Wn. 2d 428 (2002). is positioned to provide for reduced
Further, a defective description in col- loan loss reserves and, in turn, lead to
lateral and incorrect filing jurisdiction lower regulatory capital requirements.
led to a lender failing to properly perfect This provides for increased liquidity and
its security interest in Fleet National bank operating margins. TSL
Bank vs. Whippany Venture I 370 B.R. 762
(d. Del 2004). Ted Sprink is senior vice president and
The exposure for lenders and outside national marketing director for the UCC
counsel often takes form in the catego- Risk Management Program of the Fidelity
ries mentioned, with litigation and loss National Financial Family of Companies.
of collateral supporting the case for UCC UCCPlus insurance policies are centrally
insurance. Other cases generally fitting underwritten and produced by Chicago
into these categories include: Title, Fidelity National Title and Ticor Title
In re Knudson, 929 F.2d 1280 (8th insurance companies, collectively a leading
circuit 1991), District of Columbia vs. Fortune 500 provider of loan-origination and
Thomas Funding, 15 UCC Rep Serv 2d closing services. Fidelity National Financial
242 (D.C.), First National Bank of Lacon purchased in December 2008 the Lawyers
vs. Strong (663 N.E. 2d 432 Ill. App 3d Title and Commonwealth Title insurance
1996), ITT Commercial Finance Corp vs. brands from LandAmerica Financial Group.
Bank of the West (166 F.3d 195 5th Cir
1999), LaSelle’s Bicycle World (120 B.R.
ucc insurance has, in many TransacTions, 579 Bankr. N.D. Okla 1990), In re Matter
reduced loan-originaTion cosTs, increased of Ellingson Motors (139 B.R. 919 Bankr .
lender and invesTor-TransacTion ProTecTion D. Neb 1991), Franklin National Bank
as well as TransParency), eliminaTed ucc- vs. Boser (972 S.W. 2d 98 Tex App. 1998),
relaTed documenTaTion defecTs and filing Avalon Software, Inc. (209 B.R. 517 D. Ariz.
errors, and shifTed risk from ouTside counsel 1997); In re: Isringhausen (20 UCC Rep
wiTh regard To The legal oPinion. Serv. 2d 366 Bankr S.D. Ill. 1993), Banque
Worms vs. Davis construction Co, Inc. 831
S.W. 2d 921 (Ky. Ct. App 1992), In re Nenko,
Inc. 209 B.R. 588 (Bankr E.D. NY 1997),
Schaheen vs. Allstate Financial Corp., 17
UCC Rep. Serv. 2d 1309 (4th Cir. 1992), and
Mellon Bank, N.A. vs. Metro Communica-
tions, Inc. 945 F.2d 635 (3rd Cir 1991).
UCC Insurance Today for Credit
Quality and Liquidity
UCC insurance has, in many transac-
tions, reduced loan-origination costs,
increased lender and investor-transac-
tion protection (as well as transparency),
eliminated UCC-related documentation
defects and filing errors, and shifted
risk from outside counsel with regard
to the legal opinion. UCC insurance has
further served to enhance the strength
and value of loans and loan portfolios
securitized or otherwise sold into the
secondary market.
Perhaps most crucial in today’s
unstable economic environment is that
lenders can now improve internal credit
52 Visit the CFA CAreer Center At www.CFA.Com.