Pub. 2 2014 Issue 2

www.uba.org 18 R ecent developments require banks to take extra precautions in attempting to perfect security interests in shares of stock held in water companies. Water is essential in Utah’s arid climate. Not surprising, Utah water rights carry a hefty price tag. For decades, Utah lenders have used borrowers’ valuable water rights to collateralize loans. Borrowers common- ly pledge their shares of stock in water companies as collateral for loans. Most banks willingly accept such pledges, but many misunderstand how to perfect their security interest in the shares, and a recent decision by the United States Bankruptcy Court for the District of Utah (Bankruptcy Court) further complicates perfection. 1 Water shares in Utah do not automatically run appurtenant (i.e., tied) to land. 2 An owner of water shares, therefore, does not convey ownership of water shares by deed, but, rather, by transferring possession of the water shares in accordance with Ar- ticle 8 of the Utah Uniform Commercial Code (UCC). 3 For the past few decades, the law on how to perfect a security in- terest in water shares has been somewhat fluid (pun intended). As a result, lenders have made their best guess on how to perfect. The issue arose in 1989 when the Utah Court of Appeals held that water shares qualify as an “instrument” under Article 9 of the UCC, and, therefore, perfection is accomplished by possession. 4 Five years later, in the Cahoon case, the Utah Supreme Court overruled the Utah Court of Appeals and held that a share of stock in a water company “represents an interest in real property and is therefore not a certificated security under [Article 9 of the UCC].” 5 In 1996, the Utah Legislature responded to Cahoon and amended the Utah Code to clarify that “the right to the use of water ev- idenced by shares of stock in a corporation shall be transferred in accordance with the procedures applicable to securities set forth in [Article 8 of the UCC].” 6 After these amendments, it was under- stood that water shares were real property rights that could be transferred like certifi- cated securities in accordance with Article 8 of the UCC. From this, lenders logically concluded that a security interest in water shares could (and should) be perfected by taking possession of stock certificates pursuant to Article 9. Despite this, in addition to possession, many lenders also included a description of the water shares in a recorded deed of trust. In January 2014, perfection of water shares was brought back into the spotlight. The Bankruptcy Court analyzed “the proper method to perfect a security interest in water shares.” 7 Acknowledging that the Utah Supreme Court had not addressed the impact of the 1996 amendments on Cahoon , the Bankruptcy Court attempted “to predict how the Utah Supreme Court would rule on that question.” 8 After a thorough analysis, the Bankruptcy Court held that the 1996 amendments require Not Perfect: Perfecting Security Interests in Wa 1 See West v. Lee (In re Anderson), Adv. Proc. No. 12-2348, 2014 WL 172222 (Bankr. D. Utah Jan. 15, 2014). 2 Utah Code Ann. § 73-1-11(4). 3 Id. at §§ 73-1-10(2), 70A-8-301. 4 Associates Fin. Servs. Co. of Utah v. Sevy, 776 P.2d 650, 652 (Utah Ct. App. 1989). 5 Salt Lake City Corp. v. Cahoon and Maxfield Irrig. Co., 879 P.2d 248, 252 (Utah 1994) 6 Utah Code Ann. § 73-1-10; see also Utah Code Ann. § 70A-8-409 (explaining that Article 8 of the UCC applies to shares of stock in a water company). 7 West, 2014 WL 172222, at *8. 8 Id.