October 2012 • Volume 100 • Number 10 • Page 514
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Secretary of State empowered to terminate fraudulent financing statements
An amendment to the Illinois UCC penalizes filing of false financing statements or liens and gives the secretary of state authority to investigate, punish, and even terminate false filings.
A recent amendment to the Illinois Uniform Commercial Code established criminal penalties and civil liabilities for those who cause a false financing statement or lien to be filed in the secretary of state's office.
The new statute, 810 ILCS 5/9-501.1, also grants the secretary of state's office the authority to conduct investigations into allegations of false filings and to terminate those filings when evidence shows the document was not authorized by the UCC, was not related to a valid financial transaction, or was filed with the intent to harass or defraud the purported debtor.
"The backdrop to this [UCC amendment] is that, during the last few years, there's been a high number of bankruptcies and lawsuits tied to failing businesses, as well as claims that people have secured interests on the money and assets of various businesses and individuals," said Hinshaw & Culbertson LLP partner Anthony J. Jacob, who chairs the ISBA Business & Securities Law Section Council.
"This amendment is really tied to foreclosures that have been occurring with individuals and businesses," Jacob said. "It appears there must have been a lot of fighting going on" in the courts between alleged debtors and creditors.
Shifting from the courts to the SOS
When a creditor wants to secure its interest in a debtor's assets, Jacob said the lender may execute a lien on the debtor's property. When properly executed, the lien becomes a secured interest and the creditor stands in line with any other secured lenders in a priority status determined at the time each creditor files with the state a financing statement giving notice of the creditor's secured status.
Jacob said a financing statement may be fraudulent if it is filed without any underlying legitimate loan agreement between the parties, or if a material omission or mistake is included in the filing.
The statutory amendment also defines "fraudulent records" under this section of the UCC to include any document that "is not authorized or permitted under Section 9-509, 9-708, or 9-808 of this Article; [that] is not related to a valid existing or potential commercial or financial transaction, an existing agricultural or other lien, or a judgment of a court…; and [that] is filed with the intent to harass or defraud the person identified as debtor in the record or any other person."
Jacob said the most important part of the recent amendment is that an alleged debtor will no longer have to go straight to court to prove that a filing was incorrect or fraudulent. The new statute allows a purported debtor to file an affidavit with the secretary of state describing any alleged defects with the lien.
Upon receipt of such an affidavit, or upon "administrative action by the Secretary of State," the secretary's general counsel and the Department of Business Services must send to the secured lender written notice of the affidavit or administrative action and provide the lender with 30 days to supply its own evidence to refute the claims.
The new statute allows the secretary of state's office to "terminate the record effective 30 days after the first request for additional documentation is sent if it has a reasonable basis for concluding that the record was communicated to the filing office in violation of subsection (a)."
Jacob said this new administrative procedure could help reduce the time and money required to obtain an initial judgment on the validity of such filings.
"You hear about the major foreclosures and bankruptcies going on that cost millions of dollars and are very time-consuming" for the litigants, Jacob said. "To now have an initial step that could be taken by a debtor whereby they can get the secretary of state to decide that the filing was fraudulent to begin with is really a big decision."
However, Jacob warned that the decision to be made could be so big that the secretary of state's office might "punt the ball" to the court system when faced with matters involving a large number of disputed facts. He said the new statute was probably intended to deal only with filings that are obviously false or invalid.
"This [amendment] is really dealing with clear and evident failures to comply with the filing process with these liens," Jacob said. "I can see the secretary of state making a decision where it's clear that something was filed improperly, but there can be a lot of shades of gray with these things."
Jacob said it is possible that courts will stay the new administrative procedure when bankruptcy or foreclosure proceedings have already commenced between the parties. He also said these kinds of disputes do not always occur between creditors and debtors.
"You can also have secured creditors fighting over this [amongst themselves]," Jacob said. "You can have a [lower-priority] secured party going in to say there's a fraudulent document because they want to [eliminate another party's secured interest] to have higher priority at getting at the debtor's assets."
Pursuant to the statute, the secretary of state's actions can be appealed to a court or tribunal, and if the secretary's decision is reversed, the document at issue would be re-filed with its priority date reverting to the original day of filing.
Also pursuant to the statute, any person found to have violated the new law is guilty of a Class A misdemeanor for a first offense, and a Class 4 felony for subsequent offenses. The guilty party would also be civilly liable to each injured person for the larger of actual damages or up to $10,000 in lieu of actual damages, plus attorney's fees, court costs, investigative expenses and, in the court's discretion, exemplary damages set by the judge or jury.
The new statute was enacted on July 20 as Public Act 97-0836.