Accounts Receivable Finance

Super Priority Liens

The accounts receivable finance borrower has performed satisfactorily for the past few years. But, unknown to the lender, something is amiss. The borrower has failed to make payments to creditors, including the IRS; is behind to the union trust fund; and has failed to pay some key trade creditors for agricultural goods. The lender has not conducted an audit for about a year, and even if it had, the lender has perfected security interest which it believes will protect fully against other creditors. Unfortunately, the lender is mistaken. All have the right to some or all of the lender's receivables, despite the prior filed security interest.

These secret liens have the potential of stripping the lenders collateral, without notice to the lender by the intervening trade creditor. Knowledge of these liens can be of great value to the secured lender in documentation, liquidation and litigation.

The IRS super-priority lien The most common of these super-priority liens is the tax lien under Section 6323 of the Internal Revenue Code, which arises when the taxpayer fails to pay a tax after assessment and demand. This lien will gain super-priority status on all assets of the taxpayer 45 days after filing and service of the lien on the taxpayer. There is no requirement that the lien be served on the secured lender.

The statute giving rise to the tax lien does not contain any provisions as to priority. Instead, its super-priority status is based on the choateness doctrine, which developed in a series of United States Supreme Court cases that upheld the priority of federal tax liens. The choateness doctrine provides that a prior perfected security interest has priority over a later-filed tax lien only if, at the time the tax lien was filed, the secured lenders lien was choate.

A secured lenders lien on accounts receivable is choate only if the lender has advanced sums to the debtor, has perfected its security interest, and the specific account receivable in question existed at the time the court measured priority, which is 45 days after the date on which the tax lien was filed and served.2 In short, accounts receivable generated 45 days after the lien filing are not choate. In order to have priority, the lender with a security interest in accounts receivable must be able to point to an assigned invoice which was in existence within 45 days after the tax lien was filed and served.

There are few defenses to the super-priority lien of the IRS, because the lien essentially terminates a debtor's interest in all property, including receivables. Lenders have asserted two main defenses in the lien statute to the IRS super-priority lien: the statutory commercial financing and the purchase money exceptions. Neither defense has proven successful.

Account Receivables