The distinction between a security interest and a mortgage is easy to understand: a security interest under Article 9 of the UCC is used for personal property, and a mortgage is used for real estate. Rarely is there any confusion between these two. However, there is a third category of collateral which blurs the lines between real estate and personal property, known as fixtures. Fixtures are items of personal property that become so affixed to real estate they become part of the real estate, but still retain their separate character. Identifying fixtures, or identifying what might be a fixture, and making the necessary filings ensures that a lender will remain perfected in those items in the event of a default or dispute among creditors.
Understanding what falls into the “fixture” category is best explained by examples. There are certain items of personal property that, once incorporated into the real estate become part of the real estate permanently: lumber, drywall, concrete, and wiring that make up a building almost certainly become part of the real estate and lose their personal property character once incorporated into a building.
On the other hand, some items are never attached to real estate and there is no real question they remain personal property such as a computer, fridge, furniture, or air compressor. Fixtures fall somewhere between these two, and the lines are blurry at best. A furnace or boiler maybe a fixture; they are hooked directly to the building and are an integral part of the mechanical system, but could also be removed and sold separately. An exhaust hood over a restaurant grill or a walk-in freezer may be similarly affixed to the building but still removable and valuable on their own. These latter examples may be fixtures, depending on the unique facts of the case.
To show just how difficult this distinction is, consider a recent case decided by the Minnesota Court of Appeals, Lighthouse Management Inc., v. Oberg Family Farms. In that case there was a dispute between a creditor with a personal property security interest in all the equipment on a particular piece of real estate, and another creditor who had a mortgage over the same real estate, which included a security interest in fixtures. In dispute was a large grain bin that had been constructed on the property; the mortgage creditor argued the grain bin was a fixture and therefore subject to its mortgage and fixture financing statement. The creditor with a security interest only argued the was personal property and thus subject to its prior security agreement. Interestingly, the bin in question was used—disassembled in Iowa and transported in eleven semi-truck loads to northern Minnesota where it was reconstructed. The bin was 132-feet in diameter and stored over 800,000 bushels of grain. According to one of the parties, 1,000 bolts were required just to affix the bin to the foundation, and construction took over a month to complete with the work of 30 subcontractors and material suppliers.
Despite these impressive facts about the construction of the bin, the Court of Appeals held there was a factual dispute about whether this grain bin became a fixture attached to the real estate or retained its personal property character and determined a judge or jury would have to make that decision at trial. The Court of Appeals offered four factors that could be considered in determining whether personal property would be considered a fixture: (1) whether the property could be removed without leaving the real estate in substantially worse condition than before; (2) whether the property can be removed without breaking it into pieces and damaging it; (3) whether the property has any independent value once removed from the real estate; and (4) the intent of the parties. None of this provides much certainty for lenders trying to determine whether property may be treated a personal property as opposed to a fixture.
Obtaining a lien in a fixture is fairly straightforward. The debtor needs to execute a security agreement which grants a lien in the property that is a fixture or may become a fixture. The security agreement for fixtures may be part of a mortgage. To perfect a security interest in fixtures, a fixture financing statement must be recorded with the county recorder’s office and include a description of the real property where the fixture will be located. A mortgage which grants a security interest in fixtures that is recorded will be sufficient to grant a security interest in the fixtures so long as the rest of the normal requirements for a financing statement are contained in the mortgage, such as including the name of the debtor, name of the secured party, and a sufficient description of the collateral.
Because of the ambiguity over whether property is or will become a fixture, the best practice will be to obtain a security interest in both fixtures and personal property. Most commercial mortgages include a grant of a security interest in personal property and in fixtures located on the real estate. While recording the mortgage in the county land records perfects the security interest in fixtures, a lender must also record a separate UCC-1 financing statement with the secretary of state in order to perfect a security interest in anything deemed personal property. Of course, security interests in property that may be fixtures are subject to the same priority rules that apply for other security interests, generally granting priority to the first party to file or record. Thus, it is important to check out any prior liens, and potentially enter into subordination agreements to determine priority.
Fixtures are items of personal property that have become affixed to and part of the real estate. Because the line between personal property and fixtures is blurry and unclear, using best practices to obtain a security interest in both fixtures and personal property is important to protect the value of collateral.
