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I wrote just a few weeks ago about the status of a Purchase Money Security Interest (PMSI). See here. I have not yet addressed the ramifications to a creditor in connection with a refinancing of a credit transaction secured by a PMSI.

First a reminder: A PMSI transaction is one in which the loan from a lender or the installment sale by a seller is related to financing the acquisition of the goods. A resulting security interest created in the goods gives the creditor a PMSI in the goods. This status of collateral is important in maintaining priority of the creditor’s security interest and helps the creditor’s position in the event of a consumer’s subsequent bankruptcy.

Next, here is a reminder about “refinancing:” The Truth-In-Lending Act and Regulation Z (TILA) require redisclosure in the event that a subsequent consumer credit transaction is deemed to be a refinance of the original transaction. That is the general rule. Certainly, redisclosure is required if an existing obligation is replaced by a new obligation. However, a reduction in the APR with a corresponding change in the payment schedule is not a refinancing, without a lengthening of the maturity or an increase in the payment amount or number of payments beyond the remaining term. (The devil is always in the details!)

But what happens to the status of a PMSI in a closed-end transaction, if the creditor and the consumer agree to refinance the original transaction? Here is when the story gets really interesting!

The answer to this status question is resolved (or not) by reference to the Uniform Commercial Code (UCC) of each state. Generally speaking, the UCC provides that in non-consumer transactions, the PMSI does not lose its status if the PMSI obligation is renewed, refinanced, consolidated or restructured. However, the uniform law does not directly answer the question for consumer transactions, and in fact, specifically declines to do so. Thus, a state-by-state analysis must be undertaken.

It seems that whether the PMSI status is maintained depends in large part on whether the refinancing is a “renewal” or a “novation”—both specific legal concepts that are beyond the scope of a blog topic. So, let me conclude by saying that creditors should consult with their attorneys on at least the following two issues in connection with developing a policy on refinancing transactions:

• Is a redisclosure required for the purposes of TILA compliance?
• Is the PMSI status of the collateral preserved or lost?

Isn’t the law interesting!

Please note: This is the one hundred forty-fourth blog in a series of Back to Basics blogs, in which relevant and resourceful information can be easily accessed by clicking here.