BILL ANALYSIS Ó SENATE JUDICIARY COMMITTEE Senator Hannah-Beth Jackson, Chair 2013-2014 Regular Session AB 1858 (Perea) As Amended June 15, 2014 Hearing Date: June 24, 2014 Fiscal: No Urgency: No RD SUBJECT Commercial law: secured transactions DESCRIPTION This bill would specify that for the purposes of filing a Uniform Commercial Code Article 9 financing statement where the debtor is an individual, the financing statement sufficiently provides the name of the debtor only if it reflects the name that is on the individual's most current driver's license, or, if the person does not have a driver's license, only if the financing statement provides the individual name of the debtor or the surname and first personal name of the debtor. BACKGROUND A "security interest" is a creditor's interest in property (usually called "collateral") to satisfy a debt in the event that the debtor defaults. In other words, a security interest is the creditor's right to have the secured property sold to satisfy the debt owed by the debtor. In order to enforce that security interest in court and potentially against other creditors, the security interest must have been properly created and perfected ("perfection" is the process of validating any legal document or interest by properly executing it and then filing it with the correct public authority, essentially putting the world on notice that an enforceable security interest exists on that property), and have priority against other security interests. Article 9 of the Uniform Commercial Code (UCC) generally governs security interests in personal property. This Article was (more) AB 1858 (Perea) Page 2 of ? vastly rewritten and modernized by the Uniform Law Commission (ULC, formerly the National Conference of Commissioners on Uniform State Laws, or NCCUSL) in the late 1990s. As a whole, the new Article 9 simplified and clarified the rules for creation, perfection, priority and enforcement of a security interest. Every state has adopted Article 9 as revised, and California's revised Article 9 (called "Division 9 of the Commercial Code") took effect on July 1, 2001. (See AB 45 (Sher, Ch. 991, Stats. 1999).) Subsequent to the enactment of AB 45 in 1999, the ULC has adopted additional amendments based upon experiences with respect to filing issues and other matters that arose in practice following a decade of experience with the prior version of the Article ("the 2010 amendments"). The ULC's goal was to have every state and territory adopt the 2010 amendments to Article 9 by July 31, 2013. Last year, AB 502 (Wagner, Ch. 531, Stats. 2013) was enacted, adopting within California's Division 9, with a delayed operative date of July 1, 2014, those changes that were made to the UCC Article 9 by the ULC. One issue, however, was ultimately left unresolved by AB 502: whether California would adopt Alternative A or Alternative B--or neither-with respect to the issue of the sufficiency of the debtor's name on the financial statement. Alternative A mandates that if a debtor has an unexpired driver's license, the correct name of the debtor can only be the name as it appears on the driver's license. If the debtor does not have an unexpired driver's license, then either the debtors' individual name" or the surname and first personal name of the debtor may serve as the correct name for filing purposes. Alternative B allows for three possible name constructions, all of which would be correct for purposes of the rule: (1) the debtor's name on the driver's license, the use of which is not mandatory; (2) the debtor's individual name; or (3) the debtor's surname and first personal name. While AB 502 originally included language to incorporate Alternative A into California law, the provision was ultimately taken out before the bill was heard in this Committee due to concerns by a prior policy committee with respect to potential for discrimination. It appears that at this time, 37 states have elected Alternative A, while a handful of others have elected Alternative B. California, having adopted neither of these rules, provides that a financing statement sufficiently provides the name of the debtor, in the case where the debtor is an individual, if the financing statement provides either of the following: (1) the individual name of the debtor; or (2) the AB 1858 (Perea) Page 3 of ? surname and the personal name of the debtor (this second option, safe harbor, was adopted by AB 502). This bill, sponsored by the California Bankers Association, would effectively implement Alternative A into Division 9 of California's Commercial Code. The bill includes language that seeks to address any concerns relating to discrimination. CHANGES TO EXISTING LAW 1. Existing law , the Uniform Commercial Code-Secured Transactions division, governs security interests in personal property. (Com. Code Sec. 9101 et seq. (Division 9).) Existing law specifies rules for the perfection of and priority given to a security interest. (Com. Code Sec. 9301 et seq.) Existing law provides that a security interest perfected pursuant to the law of the jurisdiction in which the debtor is located, as specified, remains perfected until the earliest of any of the following: the time perfection would have ceased under the law of that jurisdiction; the expiration of four months after a change of the debtor's location to another jurisdiction; or the expiration of one year after a transfer of collateral to a person that thereby becomes a debtor and is located in another jurisdiction. (Com. Code Sec. 9316(a).) Existing law generally provides that a financing statement (the filing of which is necessary to perfect a security interest in collateral) is sufficient only if it satisfies all of the following conditions: it provides the name of the debtor; it provides the name of the secured party or a representative of the secured party; and it indicates the collateral covered by the financing statement. (Com. Code Sec. 9502(a).) Existing law provides that a financing statement sufficiently provides the name of an individual debtor only if the financing statement provides either of the following: the individual name of the debtor; or the surname and first personal name of the debtor. (Com. Code Sec. 9503.) This bill would, instead, provide that a financing statement AB 1858 (Perea) Page 4 of ? sufficiently provides the name of the debtor only if it does so in accordance with the following rule: if the debtor is an individual to whom the Department of Motor Vehicles (DMV) has issued a driver's license that has not expired or an identification card that has not expired, only if the financing statement provides the name of the individual indicated on that driver's license or identification card ("driver's license rule"); or if the debtor is an individual to whom the above does not apply, only if the financing statement provides the individual name of the debtor or the surname and first personal name of the debtor ("safe harbor"). This bill would provide that if the DMV has issued to an individual more than one driver's licenses or identification cards of a kind described above, the relevant driver's license for the above propose refers to the most recently issued license or card. This bill would provide for the above purposes, "driver's license" includes an original driver's license issued by the DMV to a person who is unable to submit satisfactory proof that the applicant's presence in the United States is authorized under federal law if he or she meets all other qualifications for licensure and provides satisfactory proof to the department of his or her identity and California residency. 2. Existing law , the Unruh Civil Rights Act, provides that all persons in California are free and equal, and regardless of a person's sex, race, color, religion, ancestry, national origin, disability, medical condition, genetic information, marital status, or sexual orientation, everyone is entitled to the full and equal accommodations, advantages, facilities, privileges, or services in all business establishments. (Civ. Code Sec. 51.) This bill would provide that, subject to the last sentence of this paragraph, it is a violation of the Unruh Civil Rights Act for a secured party or proposed secured party to decline to provide credit to a debtor or proposed debtor, or offer to make the terms and conditions of the credit less favorable to the debtor or proposed debtor if (A) that decision was based on the fact that the debtor's name to be included on the financing statement is or would be that provided under the safe harbor to the driver's license rule, above, and (B) all AB 1858 (Perea) Page 5 of ? elements that would be required to establish a claim for violation of Unruh (including any elements relating to motivation or state of mind) are established. Any affirmative defenses that would be available to a claim under Unruh would be affirmative defenses to a claim under this paragraph. 3. Existing law provides transitional provisions that govern the effect and priority given to securities perfected prior to or after the operative date of the 2001 changes to Division 9, as well as for those security interests perfected prior to or after the 2010 changes to Division 9. (Com. Code Secs. 9701 et seq., 9801 et seq.) This bill would include similar transitional provisions for these 2014 amendments that govern the effect and priority given to securities perfected prior to or after the operative date of this bill. For example, the transitional provisions would provide: The changes to this division made this bill become operative on January 1, 2015. This bill's transitional provisions apply to a security interest only to the extent that, with respect to such security interest, both of the following apply: o a debtor is an individual; and o a financing statement filed before January 1, 2015, provides the name of an individual as a debtor. Except as otherwise provided the bill's transitional provisions for the 2014 amendments, the changes to this division made by this bill apply to a transaction or lien within its scope, even if the transaction or lien was entered into or created before January 1, 2015. The changes to this division made by this bill do not affect an action, case, or proceeding commenced before January 1, 2015. The provision above relating to the anti-discrimination language as added by this bill applies only with respect to events occurring on or after January 1, 2015. A security interest that is a perfected security interest immediately before January 1, 2015, is a perfected security interest under this division as amended by this act if, as of January 1, 2015, the applicable requirements for attachment and perfection under this division as of that date are satisfied without further action. A security interest that is an unperfected security interest immediately before January 1, 2015, becomes a perfected security interest as follows: AB 1858 (Perea) Page 6 of ? o without further action, on January 1, 2015, if the applicable requirements for perfection under Division 9 as amended by this bill are satisfied before or at that time; and o when the applicable requirements for perfection are satisfied if the requirements are satisfied after that time. The changes to this division made by this bill determine the priority of conflicting claims to the collateral. However, if the relative priorities of the claims were established before those changes become effective and operative on January 1, 2015, this division as it existed before those changes become effective and operative determines priority. COMMENT 1. Stated need for the bill According to the author: Banks and other lenders provide loans to individual borrowers, loans which are frequently business purpose loans to sole proprietorships secured by accounts receivable, inventory and equipment. To obtain a priority security interest in such collateral, the secured creditor most often has to file a Uniform Commercial Code (UCC) financing statement in the state where the borrower is located. The UCC requires that the secured party identify the "name of the debtor" on the financing statement. When the borrower is an entity such as a corporation, determining the name is relatively easy, as there is an organic record of that name within the state where the entity was formed. For example, with a corporation that is a borrower, its name for filing purposes would be derived from the name listed in its filed Articles of Incorporation. But when lending to a sole proprietorship (an individual), the secured party has little statutory guidance as to the source for that name. Is it the name appearing on a tax return, a birth certificate, a social security card, a passport, a marriage license, a business card, a driver's license or a state identification card? Therein lies the problem for secured creditors today. Article AB 1858 (Perea) Page 7 of ? 9 of the UCC does not clearly define what the name of an individual debtor is for these purposes. Lenders struggle to determine what name to file upon and also what name or names to search for in order to identify other secured parties who might have filed before them. AB 1858 would require the lenders to use the name indicated on the borrower's driver's license when they file a Uniform Commercial Code (UCC) financing statement. If the borrower does not have a driver's license, then it would be filed with the first name and surname. This is known as Alternative A. Alternative A states that the name on a financing statement filed against an individual debtor will only be sufficient if it provides the name indicated on the debtor's driver's license (if the debtor does not have an unexpired driver's license, then it is to provide the individual name or the surname and first personal name). 2. Sufficiency of the debtor's name on a financing statement In 1990, the Permanent Editorial Board for the Uniform Commercial Code, with the support of its sponsors, the American Law Institute and the National Conference of Commissioners on Uniform State Laws (NCCUSL, now known as the Uniform Law Commission (ULC)), established a committee to study Article 9 of the UCC and to make recommendations to the Board. In 1992, the study committee recommended that the Board create a drafting committee to reorganize the UCC Article 9 and recommended various changes. The drafting committee met 15 times between 1993 and 1998, until the sponsors (ALI and the NCCUSL) approved the new, revised Article 9. However, the ULC did not reach consensus on the appropriate, and uniform, way to address the question of the sufficiency of the debtor's name on a financing statement. Instead, the ULC provided two options (arguably with a third option of choosing neither alternative): Alternative A and Alternative B. Alternative A requires that, at the risk of being found unperfected, the name presented on the financing statement must be exactly as shown on the debtor's driver's license. The debtor's individual name, or his or her surname and first name can only be used in the absence of an unexpired driver's license. Alternative B permits the use of the debtor's driver's license name, while also allowing for use of the debtor's actual (or individual) name, or his or her surname and first personal name. Generally, Article 9 applies to any transaction, regardless of AB 1858 (Perea) Page 8 of ? its form, that creates a security interest in personal property or fixtures by contract. The filing of a financing statement is necessary to perfect a security interest and the statement is sufficient only if it satisfies certain conditions, including the name of the debtor. Thus, the issue of the debtor's name is critical, because if the financing statement does not provide the so-called "correct" name of the debtor, then it does not perfect the security interest. While it might seem as though that every person only has one correct name, it is, in reality, not that simple. An individual debtor in a security interest transaction could be known by various names: a birth certificate name, driver's license name, passport name, or even a nickname. Moreover, names can be changed: hyphens added or removed, middle names dropped, maiden names made middle names, maiden names dropped or readopted-the list goes on. If a creditor does not identify the name correctly and the security interest is thereby not perfected, someone else might perfect a security interest in the same property of the debtor and gain priority over the original creditor's security interest by the time the error is fixed. Under California law, as amended by AB 502 (Wagner, Ch. 531, Stats. 2013) operative July 1, the name on the financing statement must be (1) individual name of the debtor, or (2) the surname and the personal name of the debtor. This bill now seeks to implement Alternative A as the rule in California for UCC Division 9 purposes. 3. Arguments for and against Alternative A In support of the bill, the California Bankers Association, the sponsor of this bill, and a coalition of supporters, writes: Alternative A is the most effective, simple and certain method for creditors to identify the name of an individual commercial borrower and provides a preferred method for the secured lending community to follow when filing and conducting searches. Alternative A ensures not only perfection, but also lien priority. A core mission of the NCCUSL is uniformity of state laws, an important goal shared by lenders that operate in multiple states. Accordingly, thirty-seven states have enacted Alternative A. Importantly, the driver's license is a primary document used to verify an individual borrower's identity under federal "Know Your Customer" requirements promulgated through the U.S. AB 1858 (Perea) Page 9 of ? Patriot Act. Given the nature of these commercial loan transactions involving a business owner, it is highly unlikely that those customers will lack a driver's license. Notwithstanding, Alternative A provides a solution in those circumstances where a business borrower cannot obtain or produce a driver's license. In this instance, the financing statement is deemed sufficient if filed under the debtor's first personal name and surname. If enacted, this measure minimizes the current documentation needed to verify the identity of a business borrower, improving the customer experience. The overall number of financing statements filed with the Secretary of State will decline reducing the filing cost associated with these commercial loan transactions while decluttering the current filing system. Meanwhile, creditors will achieve greater efficiency. In opposition to the bill, a group of 10 law professors who teach commercial or debtor/creditor law across eight law schools, including Boalt (UC Berkeley), UC Hastings, UCLA, Loyola, Santa Clara, among others, argue that the current rule, which has been in place for over 50 years, in conjunction with the added safe harbor (i.e. surname and first name of the individual) that is to go into effect on July 1, 2014, per AB 502 (Wagner, Ch. 531, Stats. 2013), is the best rule for California. The professors write that, in contrast to other states, "[n]o 'fix' is needed in California because we already have an excellent filing and searching practice that does not present the problems which the large banks assert require a drastic change of law, a change likely to present difficulties for small financial institutions, small law firms and solo practitioners, sellers of equipment and sellers of inventory to retailers, and ultimately their borrowers, clients and buyers, especially SME's [small and medium enterprises]." Moreover, they note that AB 60 (Alejo, Ch. 524, Stats. 2013) was adopted just last year, allowing undocumented people to apply for a driver's license and urge caution against moving too fast in California: The applications may trigger changes in the Department of Motor Vehicles' name presentation practices to contend with Hispanic surname practices, matronymics/ patronymics presentation, accent marks, tildes, multi- element names, Asian name presentation practices and other issues too numerous to mention, as well as those that we cannot AB 1858 (Perea) Page 10 of ? anticipate. If the legislature now ties UCC names to DMV names, decisions made by DMV officials, whose primary concerns are with law enforcement and with efficiency and costs of operating the DMV system, will be imposing changes on a UCC system that exists for entirely different purposes that are of no concern to them. Moreover, long-standing UCC filing and searching practices may change in unpredictable ways. The overall result of imposing the license name rule may well be to introduce uncertainty under the UCC and require judicial clarification. That in turn may affect the availability and cost of secured lending in California and generate malpractice litigation. They believe that since AB 60 does not go into effect until January 1, 2015, this is the absolute wrong time to impose the driver's license name rule on UCC practice. "At the very least, the Legislature should postpone all further change to UCC [Section] 9-503 and allow the law on the books to continue as is. If the large banks continue to urge use of the license as the source for the UCC name, the Legislature should consider that in two or three years, after the effects of AB 60 are known and after a careful study. Some of us would be willing to serve on a study group and undertake to report to this Committee." Professor Harry Sigman, in opposition, adds that the proponents have understated who the bill would effect and overstated the benefits of Alternative A. While one might argue that the proponents of this bill are the parties who stand to lose if they get the name wrong for the purpose of perfection, Professor Sigman points out that commercial filers such as the big banks are not the only filers who would be affected by this bill-indeed, "UCC Article 9 is used by sellers of equipment, sellers of small businesses, parties who are seeking to secure the promises of counterparties in various business transactions, divorces, child custody arrangements," as well as by local banks and credit unions, and by bigger national banks, among others. Accordingly, the proposed change to move California to a driver's license rule could cause complications for these other non-commercial, and potentially less-sophisticated, filers. Moreover, Professor Sigman challenges both the stated need for the bill, and the benefits of cost-efficiency and uniformity that are presumed to result from adoption of Alternative A. To this end, he explains that whereas in other states, a search of "B. Obama" would only disclose an exact match for "B. Obama," causing the filer to search all possible variations individually, at additional cost, in California, the initial "B. AB 1858 (Perea) Page 11 of ? Obama" search would disclose all fillings against any variation of the name "B. Obama." Furthermore, the professor argues that even under Alternative A, no well-advised prospective secured creditor would search only under the driver's license name, as both California state tax liens and judgment liens are filed in the Secretary of State's office and indexed with the UCC financing statements-neither of which are required to use the debtor's driver's license name. Staff notes that Alternative B would arguably include some flexibility as to what is the "correct" debtor's name, which might address some of the oppositions concerns. That being said, the proponents of AB 1858 would argue that Alternative B is not preferable as it provides less certainty than Alternative A as it allows more than one name of an individual to be used on a financing statement-which means that lenders who want to obtain a first priority security interest will continue to face uncertainty as to what names to search under. Moreover, they argue that Alternative B does not guarantee that filing under the driver's license name will give the lender priority, because prior filings made by other lenders under other names may be sufficient under Alternative B. So, under Alternative B, lenders can be expected to continue to deal with additional time, confusion, and cost in defining an individual name for the purposes of filing and searching. 4. Anti-discrimination language California law, the Unruh Civil Rights Act, provides that all persons are free and equal, and that regardless of a person's sex, race, color, religion, ancestry, national origin, disability, medical condition, genetic information, marital status, or sexual orientation, everyone is entitled to the full and equal accommodations, advantages, facilities, privileges, or services in all business establishments. (Civ. Code Sec. 51(a).) This bill would provide that it is a violation of the Unruh Civil Rights Act for a secured party or proposed secured party to decline to provide credit to a debtor or proposed debtor, or offer to make the terms and conditions of the credit less favorable to the debtor or proposed debtor if (A) that decision was based on the fact that the debtor's name to be included on the financing statement is or would be that provided under the safe harbor to the driver's license rule, above, and (B) all elements that would be required to establish a claim for AB 1858 (Perea) Page 12 of ? violation of Unruh (including any elements relating to motivation or state of mind) are established. Any affirmative defenses that would be available to a claim under Unruh would be affirmative defenses to a claim under this paragraph. As currently drafted, the bill would require, for the first time in statute, that for there to be a violation of Unruh, the plaintiff must prove any elements relating to motivation or to state of mind. Staff notes that this is not language drawn from the Unruh statute, nor is such language referenced in any other statute in relation to potential Unruh violations. Even if those elements would be necessary to a successful Unruh action, to include this language in the proposed statute could be misleading. Moreover, as currently drafted, there is a potential concern that the bill could inadvertently be read to limit what would constitute an Unruh violation. Insofar as discrimination is a concern, that concern potentially arises out of the decision to decline credit or to make the terms and conditions less favorable based upon the fact that the person either did not have a valid driver's license, declined to provide their driver's license for the purposes of identification, or presented a driver's license issued under last year's AB 60 (see Comment 2 above) indicating that he or she is an undocumented immigrant. The violation could feasibly also arise because the detrimental decision is made based on a presumption by the creditor (or his or her agent) that any person who claims to not have a license is actually a person with an undocumented immigrant's license or is otherwise an illegal immigrant. The current language of the bill, however, does not appear to recognize that possibility and the language should therefore be clarified avoid any confusion. Accordingly, the following amendment is suggested to strike reference to motivation or state of mind and to clarify that this bill is not intended to restrict what otherwise constitutes an Unruh violation under existing law: Suggested amendment : On page 4, starting at line 3, amend the bill to read: "(7) Subject to thelastfollowing sentence of this paragraph, it is a violation of Section 51 of the Civil Code for a secured party or proposed secured party to decline to provide credit to a debtor or proposed debtor, or offer to make the terms and AB 1858 (Perea) Page 13 of ? conditions of the credit less favorable to the debtor or proposed debtor if (A) that decision was based on the fact that the debtor's name to be included on the financing statement is or would be that provided under paragraph (5) rather than under paragraph (4), and (B) all elements that would be required to establish a claim for violation of Section 51(including any elements relating to motivation or state of mind)are established. Any affirmative defenses that would be available to a claim under Section 51 would be affirmative defenses to a claim under this paragraph. Nothing in this paragraph shall be construed to alter, expand, limit, or negate any other rights, defenses, or remedies under Section 51. " Staff notes that the bill was also recently amended to include among the transitional provisions for these 2014 amendments to Division 9 a statement to the effect that the anti-discrimination language as added by this bill applies only with respect to events occurring on or after January 1, 2015. Such language is not only unnecessary, as the transitional provisions make clear that the changes under this bill apply as of January 1, 2015, but it could also have an effect of limiting Unruh. The following amendment is suggested to delete this provision. Suggested amendment : On page 5, strike lines 32-34, inclusive Support : Association of Financial Development Corporations; Bay Area Council California Business Roundtable; California Chamber of Commerce; California Credit Union League; California Independent Bankers; California Mortgage Bankers Association; Latin Business Association; National Federation of Independent Business Opposition : 10 law professors HISTORY Source : California Bankers Association Related Pending Legislation : None Known Prior Legislation : AB 502 (Wagner, Ch., Stats. 2013) See AB 1858 (Perea) Page 14 of ? Background. Prior Vote : Assembly Floor (Ayes 73, Noes 0) Assembly Judiciary Committee (Ayes 10, Noes 0) **************