The hidden power of the second UCC position. Be careful.

We all know he basic rule: First to file is first in priority and  therefore gets every dollar it is owed before the second lien holder gets anything. The second UCC filed, the second in priority, gets its first dollar only after the first priority lien holder gets all that is owed to them.

That’s the rule and this usually means the second lien holder gets nothing, because the only time this is meaningful is usually in a foreclosure/defaulting situation and then it is unlikely that the first lien holder will ever get all it is owed, thus the second lien holder usually gets nothing.

So, if the second lien holder gets nothing so where is its power?

The fact remains the second lien holder is attached to the collateral. It must be dealt with in some way or its mere existence without release can prevent the transfer of the title of the asset it is attached too. Thus if a sale  of the asset is arranged the second lien holder must release for the transfer to occur.

The only other option is for the first lien holder to foreclose on the asset and thus blow off the subordinate debt, it all being discharged along with the lien. Problem is this frequently requires timely business interruption and the purchaser is long gone no longer interested in what remains. Thus the second lien holder while not entitled to a payoff was strong enough to interfere with an orderly sale and transition, and thus stopped the desired result.

Therefore the buyer, or seller, or first lien holder bank, sometimes pays off the second lien holder with some modest payment as incentive to release and allow the first to sell and collect all that is available.. The first lien holder can always foreclose the second out, but then frequently the sale is lost.

It is sort of payoff money, a kick back to leave so the first can collect more then it would through foreclosure. This can be a very strong and compelling argument that gets sufficient attention to get a handout that is undeserved but sometimes paid.

Thus be careful when you confront such a situation, it is not as black or white as it may at first appear, the second lien holder can be a deal breaker or force a payment it is not entitled to receive….but does get anyway.