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When Is An LLC Needed

When Is An LLC Needed

When Is An LLC Needed

Want to Get your LLC Drafted?

When is an llc neededWe want to help you out on your business journey and explain to you when a corporate liability shield, like an LLC or corporation is needed or not.

As small business owners it can be extremely valuable to find guidance in what you should be doing for your business and when.

We are going over when you need to get a liability shield for your business.

There is no requirement that you create an LLC before you go into business, it can be a smart move and highly recommended sometimes but is not necessary to have your business running.

You can just start sending out invoices and creating value from your labor or sales of goods. Start helping people and charge appropriately.

Needing or not to create an LLC will depend on the type of business you own and its structure.

If you are wondering if you should have an LLC for your business and if the benefits will outweigh the cost and hassle of setting one up, this will definitely interest you:

 

Want to Get Your LLC Drafted?

What is an LLC

 

LLC stands for limited liability company. It’s a business structure that provides a business with limited liability. Although the structure is similar to corporations, the LLC is easier to establish and simpler to maintain.

The key aspect of LLCs is that it  provides protection to the LLC owners by limiting the owner’s personal liability

Meaning that debts owed by the business, and other claims, like liens and lawsuits, are limited to the assets of the business itself, and in no case to the owner’s.

Therefore the personal assets of the business owners, under most circumstances, are protected and cannot be pursued.

Be careful, that does not mean owners are protected from negligence or  illegal acts committed in the name of the LLC.

 

What would an LLC do for your business?

 

An LLC gives your business a legal identity on it own. It becomes a separate “person” in the eyes of the law and it can own money, have a bank account, make agreements, buy property, sue and be sued.

Not having an LLC means that you and your business aren’t legally separate, and everything you own is at risk if your business is facing liens lawsuits or others

 

Does My Business Need an LLC?

The first thing you should do to see if it is time to start an LLC is: examine your business. Ask yourself these questions:

 

  • Do you have partners?
  •  Do you have high risk transactions?
  • Do you sell food?
  • How about anything where you have locations that could be sites of slips and falls?

 

If you need to form an LLC yet or not will mostly depend on your liability and taxes.

when is an llc needed

Many businesses are sole proprietors, so they cannot have all the disputes that partnerships can. Therefore, they are less likely to need an LLC until we look at what they are doing and how much they are making.

 

How about your blog that you have monetized with advertisements and merch, or online courses.  Does that business need an LLC?  Not until they are making tens of thousands of dollars a year.

 

In that case the transactions are all at a low price point.  A few dollars for online ads and some sales of merchandise money. There is not much risk there. Someone is not going to have a slip and fall on your website. No one is going to get food poisoning from your online course. There is no liability benefit from splitting the cash flows away from the owner.

 

In this situation, it does not make sense to form an LLC until you get enough money each year to get hit on taxes so much that it makes more sense to become an s-corp so that you can work for yourself and get a paycheck from your own company and earn lower tax on the dividends. But that’s a tax question that can change over time.

 

What if you are the sole proprietor of a bar & restaurant? You need an LLC immediately. You have huge risks. Slip and falls, food poisoning, over serving a customer that gets in a car accident on the way home from your place. An LLC allows the owner to be a legally separate person than the cash flows.

 

How about an independent contractor that does home improvements? Then you want the liability shield because your job to redo a kitchen and bath could be 40 grand or more. You want that to be the company’s problem, not the owners. Large transactional liability is another reason to form the LLC. So if you are in enterprise sales, get an LLC.

 

Finally, partners complicate things far more. When you break up the ownership all sorts of things arise. How do partners exit the business; how do new people get into the business; what duties do the owners have to the business; and much more. Multiple owners of any business, as far as I’m concerned, always should have an LLC.

 

Want to Get Your LLC Drafted?

Key Points to consider when doubting to create or not an LLC

 

  • You need an LLC when you have premises liability, brick and mortar stores.
  • You need an LLC when you have transactional liability. Protect the big fat contract checks.
  • You need an LLC when the tax man says you earn too much as a sole proprietor so get an accountant.
  • You need an LLC when you have partners. Be smart, have an exit plan before you start with any partners.

 

How to Start an LLC 

Now that you know when you need an LLC – let’s talk about how to form one.  Make sure you you follow us for future content! 

Filing with the State

If you are a small business, it would probably make more sense to start your LLC in your home state.

But you should know that there are other states to fill your LLC that may be more favorable  due to beneficial tax laws and business infrastructures. 

If you serve a local demographic you should file in that state, but for cyber or internet type of business the location has no real importance and you could research the state regulations that fit your business model best.

Each State has its own process when it comes to filing the articles of organization for an LLC.

Most of them offer to file online making the process easier, otherwise, you’ll have to fill out the articles of organization by hand and send it to your Secretary of State’s Office.

 

Determining If You Want To Be Manager or Member Managed

There are two forms of management for an LLC, it can be managed by the members or managed by a manager:

manager-managed LLC: Creates a manager role separated from the ownership. The manager has the authority to decide on the day to day operations. But the owners have authority for higher level decisions.

Member-managed LLC: the owner or one of the owners is the manager and handles operations accordingly.

 

Getting a Registered Agent

A Registered Agent is a person that could be a member of the LLC, or a third-party who acts on behalf of the LLC to collect legal notices from the State or other. 

The registered agent needs a physical address in the State in which the company is registered. 

If you do decide to incorporate an LLC in a different state from where you live, you will need to find a Registered Agent that resides in the same state where you incorporated your business. 

 

Drafting an Operating Agreement 

Next step is to draft your LLC Operating Agreement which is intended to be kept for internal record-keeping. This is where the ownership percentage of the company is outlined. Here are a few important things you should include in your LLC Operating Agreement:

  • Names of all Members and all their signatures
  • Members’ Percentage Interests and Capital Contributions
  • Date of Annual Meetings

Once your LLC Operating Agreement is complete, each Member should have a copy.

 

Getting an FEIN Number

A FEIN is a Federal Tax Identification Number, also heard of as an Employer Identification Number (EIN), is issued to companies that do business in the United States. It iis a unique nine-digit ID number, like a security number but for companies. 

  • A FEIN is a way for government entities to identify and track businesses tax and financial activities.
  • A FEIN is required to file tax returns, and to set up accounts to offer benefits to employees

Not every small business needs a FEIN, but the following do:

  • Any business with employees.
  • Any business that operates as a corporation or a partnership.
  • Any business that pays employment, alcohol, tobacco or firearms tax returns.

You can apply for a FEIN

  • By phone.
  • By fax or mail:
  • On the IRS website

Even if your business is not required to have a FEIN, you may decide to get one. There is no charge, and you never know when your business circumstances change.

 

Thomas Howard

Thomas Howard

Real Estate Lawyer

Whether this is your first land use issue or most recent, our office has helped people and businesses alike.

Thomas Howard was on the ball and got things done. Easy to work with, communicates very well, and I would recommend him anytime.
R. Martindale

Need A Business Lawyer?

Call our law offices with your legal questions for help on:

  1. real estate contracts
  2. business contract disputes
  3. Shareholder litigation
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  5. fraud actions
  6. mechanic's liens

 

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    Agriculture Bankruptcy & Marshalling of Assets

    Agriculture Bankruptcy & Marshalling of Assets

    marshaling equitable doctrine

    General marshaling principles.

    The equitable doctrine of marshaling rests upon the principle that a creditor having two funds to satisfy his debt should not be permitted to arbitrarily prejudice a junior creditor who may resort to only one of the funds. Meyer v. U.S., 375 U.S. 233, 236, 84 S.Ct. 318, 11 L.Ed.2d 293 (1963)

    Bankruptcy and Ag Financing Issues

    The greatest challenge to any secured transaction arises when a borrower files a proceeding under the Bankruptcy Code. Originally enacted in 1986, Chapter 12 of the Bankruptcy Code provides a procedure by which family farmers, as defined by the Code (see 11 U.S.C. §101(18)), can restructure debt. A permanent extension of Chapter 12 was enacted as part of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA), Pub.L. No. 109-8, 119 Stat. 23. See Terrell Lee Sharp and Bentley J. Bender, Ch. 7, Chapter 12 Bankruptcy Tips and Procedures, CONSUMER BANKRUPTCY PRACTICE (IICLE®, 2011, Supp. 2013).  In 2019, the Family Farmer Relief Act (H.R. 2336) raised the debt limits on Chapter 12 to dramatically expand its application for farmers with debts totally $10 million, up from the previous $4.4 million.

          Whenever a dispute arises in a bankruptcy case as to the lien rights of a lender, an adversary proceeding will be filed to determine the validity, priority, or extent of a lien under Rule 7001(2) of the Federal Rules of Bankruptcy Procedure. Regardless of whether the adversary proceeding is brought by the lender, the debtor, or the trustee, the adversary proceeding provides the vehicle by which all legal and equitable theories may be tested. See, e.g., Illini Bank v. Clark (In re Snyder), 436 B.R. 81 (Bankr. C.D.Ill. 2010).

    Problem Ag Loan

    the equitable doctrine of marshaling

    At issue in Illini Bank was whether the equitable doctrine of marshaling should be applied to the benefit of Tri Ag, Inc., the holder of a junior lien against certain crop proceeds held by the Chapter 12 trustee. Illini Bank, as the assignee of the senior lienholder, wanted the funds for itself and opposed marshaling. In the debtors’ Chapter 12 petition and schedules, Mr. Snyder listed himself as a farmer and Mrs. Snyder listed herself as retired. However, the schedules for real property and personal property listed them as jointly owned.

          Tri Ag’s debt of $123,342 was the oldest. In February 2006, only Mr. Snyder signed a security agreement covering all crops grown on real estate farmers in bankruptcylocated in Logan and Mason Counties. To perfect that security interest, a UCC financing statement naming him as the sole debtor was filed on April 7, 2006.

          Unfortunately for Tri Ag, AG-LAND loaned money to the debtors and, on February 27, 2006, filed a UCC financing statement naming both as debtors. AG-LAND was owed $130,897.05. Thus, AG-LAND had the prior security interest in all growing and harvested crops. In 2007, both debtors borrowed money from Illini Bank and granted it a security interest in crops, machinery, and equipment, among other property. After the bankruptcy case was filed, Illini Bank purchased AG-LAND’s position and thereby leapfrogged from third to first priority on the crop lien. Tri Ag and Illini Bank filed cross-motions for summary judgment on the issue of marshaling an application of the total crop proceeds of $100,520.88.

          The first issue the court decided was that the direct and circumstantial evidence supported the conclusion that Mrs. Snyder owned half of the crop proceeds. Consequently, because she failed to sign the Tri Ag security agreement, Tri Ag acquired and held a lien on only one half of the proceeds.

          Next, the court rejected Illini Bank’s argument that the doctrine of marshaling should fail. Instead, the court held that marshaling could be applied to protect the one-half interest held by Tri Ag. The court noted that if AG-LAND had not sold its claim to the bank, AG-LAND, because it held a first priority lien on crop proceeds and on machinery equipment, would have been substantially oversecured. As a result, Illini Bank took the assigned claims subject to the marshaling rights of Tri-Ag.

    Thomas Howard

    Thomas Howard

    Real Estate Lawyer

    Whether this is your first land use issue or most recent, our office has helped people and businesses alike.

    Thomas Howard was on the ball and got things done. Easy to work with, communicates very well, and I would recommend him anytime.
    R. Martindale

    Need A Business Lawyer?

    Call our law offices with your legal questions for help on:

    1. real estate contracts
    2. business contract disputes
    3. Shareholder litigation
    4. cannabis business
    5. fraud actions
    6. mechanic's liens

     

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      Filing Financing Statements and Determining Priority

      Filing Financing Statements and Determining Priority

      Determining Priority

      Determining Priority in Perfected Security Interests

      Who’s on first? This question decides what creditor gets paid, and what becomes an unsecured creditor whose best option is to recover pennies on the dollar for the money loaned to a business that purportedly had collateral. Priority to collateral needs determination to see who can seize it in satisfaction of its indebtedness to the business. 

      How and Where to File UCC Financing Statements

       

      As a general rule, in all secured transactions involving a security agreement executed by the debtor, the debtor authorizes the secured party to file a financing statement describing the collateral. See 810 ILCS 5/9-509(a)(1).  A financing statement perfects the lien in the collateral securing the transaction, often a loan to a business.

      The financing statement is filed with the Secretary of State’s office in which the collateral is located, or the lien arose because some collateral is mobile. In addition, Article 9 provides that a person holding an agricultural lien that arises by operation of law and requires no written agreement may file a financing statement without consent provided the financing statement covers “only collateral in which the person holds an agricultural lien.” 810 ILCS 5/9-509(a)(2).

      UCC Financing Statement Filing

      Problem Ag Loan

      UCC Financing Statement Illinois Example

      UCC Financing Statement Illinois

      A UCC 1 in Illinois is common knowledge for commercial bankers and you can find a copy of the fillable PDF form LINKED HERE.

      Description of Collateral for Perfection of UCC Lien

      The financing statement does not need to include the legal description of leased real estate as a condition of perfection. Article 9 only requires this description only for “as-extracted collateral or timber to be cut.” 810 ILCS 5/9-502(b). “As-extracted collateral” means oil, gas, or other minerals that are subject to a security interest that is created by a debtor having an interest in the minerals before extraction and attaches to the minerals as extracted. 810 ILCS 5/9-102(a)(6). However, a legal description may be appropriate as an indication of “the collateral covered by the financing statement.” 810 ILCS 5/9-502(a)(3). One example is the landlord’s lien on crops growing on specific acreage. When the debtor is a tenant farmer that does not have a record interest in the real estate, counsel also must provide the name of the record owner. 810 ILCS 5/9-502(b)(4).

      With a few exceptions, all financing statements are required to be filed in the office of the Secretary of State. 810 ILCS 5/9-501(a). The law governing perfection of priority of security interests is generally determined by the location of the debtor. 810 ILCS 5/9-301. For agricultural liens, the law governing priority is the local law of the jurisdiction where the farm products are located. 810 ILCS 5/9-302.

      The debtor’s location depends on how the debtor is conducting the farm business. When a debtor is an individual, he or she is located at the individual’s principal residence. When the debtor is a non-registered organization, such as a general partnership, it is located at its place of business or its chief executive office if it has more than one place of business. 810 ILCS 5/9-307(b). However, when the debtor is an organization that is organized under state law, like a corporation or a limited liability company, it is located in the state where it is registered. 810 ILCS 5/9-307(e). The failure to file in the proper jurisdiction or to otherwise fail to satisfy the specific requirements for completing and filing the financing statement can be fatal. See, e.g., Duesterhaus Fertilizer, Inc. v. Capital Crossing Bank (In re Duesterhaus Fertilizer, Inc.), 347 B.R. 646 (Bankr. C.D.Ill. 2006).

      Priorities: Which Agricultural Lien Wins?

      In a conflict between security interests and agricultural liens in the same collateral, priority generally dates from the earlier of the time the filing covering the collateral is first made or the security interest or agricultural lien is first perfected. See 810 ILCS 5/9-322, 5/9-338.

      A perfected security interest in growing crops has a priority over a conflicting interest of the owner or the mortgagee of the real property on which such crops are grown. 810 ILCS 5/9-334(i)(1)(A). The same priority applies between an assignee of a beneficial interest in an Illinois land trust and the holder of a perfected security interest in crops. See 810 ILCS 5/9-334(i)(1)(B). Lenders financing farm real estate that also want to maintain priority in crops must comply with Article 9 of the Uniform Commercial Code.

      Problem Ag Loan

      Thomas Howard

      Thomas Howard

      Real Estate Lawyer

      Whether this is your first land use issue or most recent, our office has helped people and businesses alike.

      Thomas Howard was on the ball and got things done. Easy to work with, communicates very well, and I would recommend him anytime.
      R. Martindale

      Need A Business Lawyer?

      Call our law offices with your legal questions for help on:

      1. real estate contracts
      2. business contract disputes
      3. Shareholder litigation
      4. cannabis business
      5. fraud actions
      6. mechanic's liens

       

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        What is an Agricultural Lien under the UCC?

        What is an Agricultural Lien under the UCC?

        agricultural lien

        What is a UCC Agricultural Lien

        As we detailed in our introductory article on security interests, a security agreement gives a creditor some form of legal right over the property of a creditor. While this definition is fairly straightforward, there are all kinds of quirks which are unique to agricultural liens. Under the 2001 amendment of Article 9 of the Uniform Commercial Code (UCC), agricultural liens are a special kind of interest for lenders.

        810 ILCS 5/9-102(a)(5) defines an “agricultural lien” to mean an interest, other than a security interest, in farm products:

        • (A) which secures payment or performance of an obligation for goods or services furnished in connection with a debtor’s farming operation;
        • (B) which is created by statute in favor of a person that in the ordinary course of its business furnished goods or services to a debtor in connection with a debtor’s farming operation; and
        • (C) whose effectiveness does not depend on the person’s possession of the personal property.

        There are at least three types of statutory liens in Illinois that involve agriculture:

        1. agister’s lien;
        2. thresherman’s lien; and
        3. landlord’s crop lien.

        Problem Ag Loan

        What is an Agister’s Lien?

        An “agister” cares for livestock. They have a special statutory lien set forth in §50 of the Innkeepers Lien Act, 770 ILCS 40/0.01, et seq.:

        Agisters and persons keeping, yarding, feeding or pasturing domestic animals, shall have a lien upon the animals agistered, kept, yarded or fed, for the proper charges due for agisting, keeping, yarding or feeding thereof. 770 ILCS 40/50.

        The agister’s lien is a possessory lien which extends animals in the care and possession of the farmer or rancher. Therefore, it does not fit the UCC definition of “agricultural lien,” and compliance with the filing requirements of Article 9 is not required.

        What is a Thresherman’s Lien?

        The next kind of lien, a a thresherman’s lien, is defined at §50a of the Innkeepers Lien Act:

        Every person who, as owner or lessee of any threshing machine, clover huller, corn sheller or hay baler, threshes grain or seed, hulls clover, shells corn or presses hay or straw at the request of the owner, reputed owner, authorized agent of the owner or lawful possessor of such crops shall have a lien upon such crops, beginning at the date of the commencement of such threshing, hulling, shelling or baling, for the agreed contract price of the job, or, in the absence of a contract price, for the reasonable value of the services or labor furnished. Such lien shall run for a period of eight (8) months after the completion of such services or labor notwithstanding the fact that the possession of the crops has been surrendered to its owner or lawful possessor, provided that such lien shall not be valid and enforceable against a purchaser of said crops from the owner or lawful possessor thereof unless the lien holder shall, previous to or at the time of making final settlement for such crops by such purchaser, serve upon such purchaser a notice in writing of the existence of such lien. 770 ILCS 40/50a.

        Unlike the agister’s lien, the thresherman’s lien continues after possession of the crops has been surrendered and therefore it fits the UCC definition of “agricultural lien.” Consequently, the rules for perfection, priority, and enforcement of this lien are provided by Article 9. Perfection is achieved by filing with the Secretary of State, and the priority rules of first to file apply. See 810 ILCS 5/9-310(a), 5/9-322.

        What is a Landlord’s Crop Lien?

        Lastly, for a landlord’s crop lien in Illinois, §9-316 of the Code of Civil Procedure, 735 ILCS
        5/1-101, et seq., provides in part:

        Every landlord shall have a lien upon the crops grown or growing upon the demised premises for the rent thereof, whether the same is payable wholly or in part in money or specific articles of property or products of the premises, or labor, and also for the faithful performance of the terms of the lease. Such lien shall continue for the period of 6 months after the expiration of the term for which the premises are demised, and may be enforced by distraint as provided in Part 3 of Article IX of this Act.

        A good faith purchaser shall, however, take such crops free of any landlord’s lien unless, within 6 months prior to the purchase, the landlord provides written notice of his lien to the purchaser by registered or certified mail. Such notice shall contain the names and addresses of the landlord and tenant, and clearly identify the leased property.

        A landlord may require that, prior to his tenant’s selling any crops grown on the demised premises, the tenant disclose the name of the person to whom the tenant intends to sell those crops. Where such a requirement has been imposed, the tenant shall not sell the crops to any person other than a person who has been disclosed to the landlord as a potential buyer of the crops. 735 ILCS 5/9-316.

        • Historically, the landlord’s lien was beyond the scope of Article 9. The most common priority dispute was between a UCC lien creditor and a landlord claiming a crop lien. The landlord’s lien usually prevailed. See Dwyer v. Cooksville Grain Co., 117 Ill.App.3d 1001, 454 N.E.2d 357, 73 Ill.Dec. 497 (4th Dist. 1983); Farmers Grain & Supply Co. v. Skinner, 161 Ill.App.3d 201, 514 N.E.2d 216, 112 Ill.Dec. 750 (3d Dist. 1987).
        •  
        • However, with P.A. 91-893, the Illinois General Assembly amended the landlord’s crop lien statute to fit within the Article 9 definition of “agricultural liens.” Furthermore, by P.A. 92-819, in 2002 the legislature added the following provision to the statutory crop lien:

        A lien arising under this Section shall have priority over any agricultural lien as defined in, and over any security interest arising under, provisions of Article 9 of the Uniform Commercial Code. 735 ILCS 5/9-316.

        As a result of this law, the landlord’s statutory lien for rent against crops grown on leased land continues to be superior to any consensual lien that the tenant may give on the crops, even those created under Article 9. Schweickert v. Ag Services of America, Inc., 355 Ill.App.3d 439, 823 N.E.2d 213, 215, 291 Ill.Dec. 203 (3d Dist. 2005) (“The 2002 amendment restored the original language of the statute as it was before the 2001 amendment.”). Therefore, the statutory lien for landlords requires no financing statement to perfect the lien.

        Limitations for Ag Liens Under Bankruptcy

        While Illinois created protections for lienholders, those protections are a different story under bankruptcy. The landlord’s statutory lien for unpaid rent may be avoided under the Bankruptcy Code, 11 U.S.C. §101, et seq. 11 U.S.C. §§545(3), 545(4). See Marshall v. Aubuchon (In re Marshall), 239 B.R. 193 (Bankr. S.D.Ill. 1999); Pogge v. Powers (In re Smith), 302 B.R. 865 (Bankr. C.D.Ill. 2003). If a landlord wants to prevail over a trustee in bankruptcy on the crop lien, the landlord needs a consensual security interest and a properly filed UCC financing statement. If a landlord fails to perfect by filing a financing statement, the statutory crop lien once avoided will relegate the landlord to the status of an unsecured creditor.

        Thomas Howard

        Thomas Howard

        Secured Transaction Attorney

        Whether this is your first land use issue or most recent, our office has helped people and businesses alike.

        Thomas Howard was on the ball and got things done. Easy to work with, communicates very well, and I would recommend him anytime.
        R. Martindale

        Need A Business Lawyer?

        Call our law offices with your legal questions for help on:

        1. real estate contracts
        2. business contract disputes
        3. Shareholder litigation
        4. cannabis business
        5. fraud actions
        6. mechanic's liens

         

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          How Do You Perfect a Security Interest in Agriculture?

          How Do You Perfect a Security Interest in Agriculture?

          agricultural security interests

          A “security agreement” is defined by the Uniform Commercial Code (UCC) as “an agreement that creates or provides for a security interest.” 810 ILCS 5/9-102(a)(74). A security agreement is “effective according to its terms between the parties, against purchasers of the collateral, and against creditors.” 810 ILCS 5/9-201(a). Or, put simply, a security agreement gives a creditor some form of legal right over the property of a creditor. To have an enforceable security agreement, creditors need to meet a series of strict requirements.

          Problem Ag Loan

          How Do You Perfect A Security Interest in Agriculture?

          A “security agreement” is defined by the Uniform Commercial Code (UCC) as “an agreement that creates or provides for a security interest.” 810 ILCS 5/9-102(a)(74). A security agreement is “effective according to its terms between the parties, against purchasers of the collateral, and against creditors.” 810 ILCS 5/9-201(a). Or, put simply, a security agreement gives a creditor some form of legal right over the property of a creditor. To have an enforceable security agreement, creditors need to meet a series of strict requirements.

          The Basics

          For a security interest against collateral to be enforceable against the debtor and third parties, 810 ILCS 5/9-203(b) requires that the following three conditions be met:

          1. Value has been given.

          2. The debtor has rights in the collateral or the power to transfer rights in the collateral to the secured party.

          3. One of the following conditions has been met:

          a. The debtor has authenticated (signed or otherwise executed) a security agreement that provides a description of the collateral and, if the security interest covers timber to be cut, a description of the land concerned.

          b. The collateral is not a certificated security and is in the possession of the secured party under 810 ILCS 5/9-313 pursuant to the debtor’s security agreement.

          c. The collateral is a certificated security in registered form, and the security’s certificate has been delivered to the secured party under 810 ILCS 5/8-301 pursuant to the debtor’s security agreement.

          d. The collateral is deposit accounts, electronic chattel paper, investment paper, or letter-of-credit rights, and the secured party has control pursuant to the debtor’s security agreement.

          These are the minimum requirements that must be satisfied to enforce a security interest. In re Duckworth, 776 F.3d 453, 462 (7th Cir. 2014).

          Common Pitfalls: Mistaken Identification

          Lenders must properly identify the debt to be secured, because §9-203 does not provide a mechanism for rescuing a lender from mistakenly identifying the debt to be secured. In Duckworth, the court held that the mistaken identification of the debt cannot be corrected against the bankruptcy trustee by using parol evidence to show the intent of the parties to the original loan. Id.

          In Duckworth, the bank brought an action against the bankruptcy trustee and others asking the court to determine that the bank had a first priority security interest in proceeds from the sale of certain farm products, equipment, and crop insurance. After the farmer filed a Chapter 7 petition, the trustee was holding $22,284.27 in post-petition sales of farm equipment and $586,740.38 in crop proceeds.

          The debtor obtained a loan from the bank by a promissory note dated December 15, 2008, in the amount of $1.1 million. On page 2 of the 2008 note, in a paragraph labeled “collateral,” it stated that the borrower acknowledged that the note was secured by a security agreement dated December 13, 2008. The debtor did sign an agriculture security agreement dated December 13, 2008, that described the collateral as all inventory, farm products, farm equipment, and crop insurance, among other property. However, in the definition of “note,” the principal amount was left blank and the note was referenced as being dated December 13, 2008; there was no cross-collateralization clause.

          The trustee and another creditor argued that the security interest was invalid because the security agreement provided that its security debt was evidenced by a note dated December 13, 2008, even though that note did not exist. The bank provided the declaration of the loan officer who prepared the loan documents and personally closed the loan. The loan officer explained that the discrepancy was a “clerical error.” The bank further maintained that the error was correctible by means of parol evidence, because Illinois adheres to the principle that documents executed as part of a single transaction are interpreted as one contractual agreement. The bankruptcy court agreed. So did the district court on appeal. However, the Seventh Circuit Court of Appeals reversed, declaring that bankruptcy trustees “are entitled to treat an unambiguously security agreement as meaning what it says, even if the original parties have made a mistake in expressing their intentions.” 776 F.3d at 463.

          The lesson from Duckworth is that special care must be taken to ensure that the security agreement contain a provision for securing future debts. Future advances or dragnet clauses are expressly permitted by the UCC. 810 ILCS 5/9-204(c). A future advances clause must be set forth in writing as part of the security agreement for the security interest to cover debts not expressly identified therein.

          See the sample form of an agricultural security agreement in §7.20 below. In the sample form of security agreement, the term “obligations” broadly encompasses all debts existing at the time of execution of the agreement and arising thereafter.

          Defining the Collateral

          Most security agreements define the “collateral,” but a mistake in the definition can be costly.  Creditors should always use language covering after-acquired property for collateral. There is no protection for creditors who mistakenly assume some kind of “common sense” inclusion applying to things like inventory.

          It is important to understand the meaning of terms defined in the Uniform Commercial Code. Some secured lenders define “accounts,” “inventory,” etc. The UCC defines many of these terms, so there isn’t necessarily a need to define them separately in the security agreement. However, it’s important to keep up-to-date on the UUC definitions. For example, some UCC terms changed dramatically when Article 9 was amended in 2001.  Therefore, a provision that incorporates UCC terms can affect the entire agreement.

          810 ILCS 5/9-102(a)(34) defines “farm products” to mean “goods, other than standing timber, with respect to which the debtor is engaged in a farming operation” and that are

          (A) crops grown, growing, or to be grown, including:

          (i) crops produced on trees, vines, and bushes; and

          (ii) aquatic goods produced in aquacultural operations;

          (B) livestock, born or unborn, including aquatic goods produced in aquacultural operations;

          (C) supplies used or produced in a farming operation; or

          (D) products of crops or livestock in their unmanufactured states.

          “Farming operation” is defined to mean “raising, cultivating, propagating, fattening, grazing, or any other farming, livestock, or aquacultural operation.” 810 ILCS 5/9-102(a)(35).

          The term “proceeds” is broadly defined to include whatever property or goods are received upon the sale, exchange, collection, or disposition of the collateral. 810 ILCS 5/9-102(a)(64). A security interest attaches to any identifiable proceeds of collateral. 810 ILCS 5/9-315(a)(2). Determining readily identifiable cash proceeds is a difficult endeavor. See C.O. Funk & Sons, Inc. v. Sullivan Equipment, Inc., 89 Ill.2d 27, 431 N.E.2d 370, 59 Ill.Dec. 85 (1982). The secured party has the burden of identifying its proceeds. Assumptions and speculation are insufficient to meet this burden. See Van Diest Supply Co. v. Shelby County State Bank, 425 F.3d 437 (7th Cir. 2005).

          The Grant

          According to Article 9 of the UCC, the grant must describe the property and what it secures. 810 ILCS 5/9-203(b)(3). This is a mandatory requirement; the failure to have a document explicitly granting a security interest is fatal. Covey v. Morton Community Bank (In re Sabol), 337 B.R. 195 (Bankr. C.D.Ill. 2006). There are no specific “magic words” required to be included in the security agreement to create a security interest, however no security interest will be recognized without a description of the collateral in a signed or authenticated document or in a separate document incorporated by reference into a signed or authenticated document. 377 B.R. at 202.

          Due Diligence and Proper Searches

          Before making a loan, a lender must make the following searches to determine whether it has priority:

          1. the debtor’s form of organization;

          2. the debtor’s principal place of business;

          3. the debtor’s predecessors;

          4. all names utilized by the debtor; and

          5. all locations used for goods.

          After the lender relies representations regarding these issues, it still must perform its own due diligence to verify the representations. This includes reviewing an entity’s articles of incorporation, articles of organization, or other organizational agreement and any other reports available to the lender to verify the locations of the collateral.

          The lender can confirm whether the borrower is a corporation or a limited liability company and in good standing at the website of the Illinois Secretary of State’s Department of Business Services at www.cyberdriveillinois.com/departments/business_services.

          The lender also must conduct a UCC lien search using the precise name of the entity or person. Failure to use the correct name can be fatal. See, e.g., Corona Fruits & Veggies, Inc. v. Frozsun Foods, Inc., 143 Cal.App.4th 319, 48 Cal.Rptr.3d 868, 870 (2006) (financing statement that listed debtor’s name as “Armando Munoz” instead of his correct name of “Armando Munoz Juarez” was seriously misleading and thus invalid). For perfection by filing a financial statement for an individual, the use of a name on a driver’s license and social security card is sufficient. In re Miller, No. 12-CV-02052, 2012 WL 3589426 (C.D.Ill. Aug. 17, 2012); see also 810 ILCS 5/9-503(a)(4).

           

          Thomas Howard

          Thomas Howard

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            Pricing LLC Membership Interest

            Pricing LLC Membership Interest

            Pricing LLC Membership Interest

            Pricing LLC Membership Interest

            Pricing LLC Membership Interest

            LLC Membership Interests

            Suppose a borrower claims to have a successful limited liability company, LLC.  He claims that his membership interest in this LLC is valuable collateral that he wants to pledge to obtain another commercial loan.

            How should the commercial lender approach valuation of the LLC’s membership interest in determining how much to lend against it?  The answer is not as straight forward as many believe because lots of restrictions against the assignment of LLC membership interests exist not only in statute, but also in the LLC’s governing contracts.

            “A distributional interest is different than a membership interest in an LLC. ”

            Picture of Collateral with low risk

            Photograph by Lorem Ipsum via Stencil

            Here’s the bullet point take aways from the video above. video above.

            • A membership interest does not mean the member owns any property of the LLC.
            • Often restrictions against the transfer of the membership interest can be found in the Operating Agreement for the LLC, or even in a state statute.
            • The distributional interest is only the right to receive distributions of profit and not engage in the management of the LLC.
            • Cap Rates are often used to value commercial real estate LLCs, but that does not mean it is so easy to value the membership interest collateral – the value is typically just the distributional interest.
            • A member’s K-1 will provide what the value of the distributional interest is.
            • Don’t just rely on the pie-in-the-sky projections of any LLC’s cash flows, confirm them before performing the calculations to arrive at a reasonable valuation for the percentage of the membership interest collateral the putative borrower wishes to pledge.
            Thomas Howard

            Thomas Howard

            Real Estate Lawyer

            Whether this is your first land use issue or most recent, our office has helped people and businesses alike.

            Thomas Howard was on the ball and got things done. Easy to work with, communicates very well, and I would recommend him anytime.
            R. Martindale

            Need A Business Lawyer?

            Call our law offices with your legal questions for help on:

            1. real estate contracts
            2. business contract disputes
            3. Shareholder litigation
            4. cannabis business
            5. fraud actions
            6. mechanic's liens

             

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