ATTORNEY/CLIENT; MALPRACTICE; UCC FILINGS:
Attorney's failure to file UCC-1 financing statement in stock that seller is transferring in connection
with transfer of all the stock in a company is negligence per se.
Lory v. Parsoff, 745 N.Y.S.2d 218 (N.Y. App. 2002)
Plaintiff alleged that the defendants (Parsoff and his law firm) negligently failed to file a UCC-1 financing
statement that would have perfected his security interest in the stock of the company sold by plaintiff,
Craftsman Sound and Security System ("Craftsman"), to Tony Amerigo and Paul Pettorino ("Purchasers"), the
third-party defendants in this lawsuit. The plaintiff further asserted that the defendants falsely
represented that they had prepared and filed the necessary documents to create a perfected security interest
in Craftsman's assets.
The plaintiff originally retained Parsoff to represent him in the sale of his stock in Craftsman. The purchase
agreement for the sale of the stock ("Purchase Agreement") called for the Purchasers to deposit all shares of
Craftsman with Parsoff, who would act as escrow agent and return the shares to the plaintiff if the Purchasers
breached any of their contractual obligations under the Purchase Agreement. The Purchase Agreement also stated
that the plaintiff was entitled to a lien on all of Craftsman's assets if the Purchasers breached the terms of
the Purchase Agreement.
The Purchasers subsequently defaulted, and the plaintiff regained complete ownership of Craftsman. Meanwhile,
the Purchasers filed a Chapter 7 bankruptcy proceeding in an attempt to avoid their obligations under the
Purchase Agreement, which bankruptcy action was eventually dismissed. Consequently, plaintiffs eventually
were restored to possession of the company.
But the plaintiff asserted injury in the bankruptcy as a consequence of loss of priority due to Parsoff's
negligence. Parsoff admitted that there had been no UCC-1 financing statement filed in the county clerk's
office in Albany or Suffolk County, and that as a consequence plaintiff alleged that it had been relegated
to the position of a creditor with an unsecured claim against Craftsman in its bankruptcy proceeding, when
Craftsman had properties to which a security interest would have attached.
During the bankruptcy proceeding, the plaintiff had accused the Purchasers of unlawfully removing office
equipment, records and logs. He also had filed an action for civil and criminal contempt, which was
later withdrawn, to prevent the Purchasers from occupying Craftsman's corporate offices. Upon commencement of
plaintiff's legal malpractice action, the defendants brought a third-party action against the Purchasers
seeking contribution and asserting that they were required to indemnify the defendants if they were found
liable to pay damages to the plaintiff.
The court found that, under New York law, "[a]n attorney's failure to file a financing statement in the manner
required by law to perfect his client's security interest constitutes negligence or malpractice as a matter of
law." The court then stated that the plaintiff had established a cause of action for summary judgment against
defendants, even though the plaintiff regained ownership of Craftsman and its assets. The court stated that,
"failure to file the UCC-1 statement is negligence per se and plaintiff is entitled to a determination as to
what such negligence cost him in terms of damages." The court ruled that the plaintiff had presented a prima
facie case for damages because the defendants acknowledged that there were no documents in their case file that
indicated that the required UCC-1 financing statement was ever filed. The court therefore granted the plaintiff'
motion for declaratory relief and directed that an inquest/hearing be commenced to permit the plaintiff to prove
any damages he could establish as the result of the defendants' failure to file the UCC-1 financing statement as
to Craftsman. However, the court refused to approve the plaintiff's request for the recovery of punitive damages,
ruling that such damages were not warranted in this case because punitive damages are not recoverable for an
ordinary breach of contract and the defendants' conduct did not rise to the level of moral turpitude and wanton
The New York Appellate Division upheld the trial court's decision that the defendants' failure to file a UCC
financing statement in the manner necessary to perfect the client's security interest constituted malpractice as
a matter of law. The appellate court further held that the trial court properly granted summary judgment on the
cause of action by the plaintiff to recover an award of an attorney fee he incurred to retain alternative counsel
as a result of the defendants' malpractice. Additionally, the appellate court ruled that there was no merit to the
defendants' challenge to the plaintiff's claim for a refund of the legal fee paid to the attorney's law firm in
connection with the negligent representation.
[Note: Under revised Article 9 of the UCC, which became effective in New York and most other states on July 1, 2001,
a security interest in stock would be considered an interest in "investment property." A security interest in
investment property may be perfected by control, by filing, or, if the investment property is a certificated security,
by possession. When the creditor perfects the security interest by filing, the local law of the jurisdiction in which
the debtor is located governs perfection of the interest. The general rule, under revised Article 9, is that the law
applicable to the perfection of security interests is the law of the debtor's location, which is generally the debtor's
place of business (or, if the debtor is an individual, the individual's principal residence) unless the debtor is a
"registered entity," such as a corporation, limited liability company, or limited partnership, in which case the
location of the debtor is the state in which it was organized. Under revised Article 9, most financing statements are
filed in a single state-wide office, such as the Secretary of State's office; there is no longer any need to file a
financing statement in the local (county) office for collateral that is not related to real estate].
As demonstrated the loss of lien perfection and priority because of the failure to properly file a UCC financing
statement can have catastrophic consequences and can expose the offending attorney (and his or her law firm) to
significant financial liability and professional embarrassment.
None of this is particularly surprising. But the case is a caution, since attornies often delegate compliance
with UCC filings to relatively low level members of their office, whereas they often rely upon title companies
to make real estate filings.
Comments by Theodore H. Sprink, Senior Vice President, Fidelity National Financial, UCC Insurance Division
This case illustrates several points, each of which could be addressed through the use of UCC insurance. First, as
noted, the court held that it is malpractice as a matter of law to fail to file a UCC financing statement where
such is required for perfection. Secondly, it may also be held malpractice, where UCC insurance is routinely
available, for counsel not to discuss the availability of such coverage with the client, particularly when the cost
is likely to be borne by the client's counterpart.
Finally, it appears the security interest was to be perfected in both the stock and the hard assets. During the UCC
insurance underwriting process the insurer, as a matter of course, is in a position, with the expertise (and claims
reserves) to advise the lawyer(s) of defects, if any, in the steps taken to perfect with respect to both forms of
collateral. This second set of eyes is invaluable to lawyers, particularly in large, complex, multi-jurisdictional
"UCCPlus Insurance Protection", introduced earlier this year by Chicago Title, Ticor Title and Fidelity National
Title was developed for just these reasons. UCCPlus insures commercial loans secured by non-real estate assets, or
"Article 9 Collateral" for attachment, perfection and priority. Coverage extends to fraud and forgery and provides
costs of defense, all for the benefit of lenders, purchasers, investors and lawyers. The UCCPlus policy also waives
the right of subrogation relative to lenders counsel.
Comments by John M. McCabe
Legal Counsel/Legislative Director NCCUSL
I think there is more to this case than perfection of a security interest in the stock of the company. Clearly,
stock in a corporation is a security under Article 8. Since Article 8 was revised in 1994 and now almost
uniformly enacted in the states, there have been two methods of perfection for a security interest in stock,
control and by filing in the appropriate jurisdiction. (The rules in 9-106 of Revised Article 9 were in Article
8 prior to the revision)Control is preferred (possession of a certificate is control under 8-106) because it
trumps perfection by filing in the event there is a priority issue between creditors. The escrow agreement in
which the stock was held by Parsoff until the buyers had fulfilled all obligations would seem to be control and
therefore perfection as I understand the concept. Why, therefore, the question about the UCC1?
Was the UCC 1 neglected filing to cover hard assets of the corporation rather than the stock? There is some
language that indicates that might have been the case. Further, the neglected filing was at the county level,
which indicates a fixtures filing at the most under Revised Article 9. New York, if my memory serves me correctly,
was a dual filing state before July 1, 2001. If the filing was supposed to precede that date, then the impact of
not filing would have been broader and more of a problem for the secured party. After July 1, only fixtures would
be locally filed.
Unless there is something other than stock, the holding in this case, given the facts, does not make a lot of
sense to me.
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