There are a number of different ways a lender can obtain a secured interest in inventories, and we consider each in turn. In the first three methods (floating lien, chattel mortgage, and trust receipt), the inventory remains in the possession of the borrower. In the last two methods (terminal warehouse and field warehouse receipts), the inventory is in the possession of a third party.
Floating lien: Under the Uniform Commercial Code the borrower may pledge inventories â€œin generalâ€? without specifying the specific property involved. Under this arrangement the lender obtains a floating lien on all the borrowerâ€™s inventory. This lien allows for the legal seizure of the pledged assets in the event of loan default.
Chattel mortgage: With a chattel mortgage, inventories are identified by serial number or some other means. While the borrower holds title to the goods, the lender has a lien on inventory. This inventory cannot be sold unless the lender consents. Chattel mortgages are well suited, however for certain finished goods inventories of capital goods such as machine tools.
Trust receipt: Under a trust receipt arrangement, the borrower holds the inventory and the proceeds from its sale in trust for the lender. This type of lending arrangement also know as floor planning, has been used extensively by automobile dealers, equipment dealers, and consumer durable goods dealers. An automobile manufacturer will ship cars to a dealer who, in turn may finance the payment for these cars through a finance company. The finance company pays the manufacturer for the cars shipped.
As the dealer buys new cars from the automobile manufacturer, a new trust receipt security agreement is signed, reflecting the new inventory. The dealer then borrows against this new collateral, holding it in trust. Although there is tighter control over collateral with a trust receipt agreement than with a floating lien, there is still the risk of inventory being sold without the proceeds being turned over to the lender. Consequently, the leader must exercise judgment in deciding to lend under this arrangement. A dishonest dealer can devise numerous ways to fool the lender.
Terminal warehouses receipt: a borrower secures a terminal warehouse receipt loan by storing inventory with a public, or terminal, warehousing company. The warehouse company issues a warehouses receipt, which evidences title to specific goods that are located in the warehouse. The warehouse receipt gives the lender a security interest in the goods, against which can be made to the borrower. Under such an arrangement, the warehouse can release the collateral to the borrower only when authorized to do so by the lender.
Field warehouse receipt: In a terminal warehouse receipt loan the pledged goods are located in a public warehouse. In a field warehouse receipt loan, the pledged inventory is located on the borrowerâ€™s premises. Under this arrangement, a field warehousing company (an independent that operates a borrowerâ€™s warehouses) reserves a designated area on the borrowerâ€™s premises for the inventory pledged as collateral. The field warehousing company has sole access to this area and is supposed to maintain strict control over it. The goods that serve as collateral are segregated from the borrowerâ€™s other inventory.
The warehousing receipt, as evidence of collateral, is only as good as the issuing warehousing company. When administered properly, a warehouse receipt loan affords the lender a high degree of control over the collateral. However, sufficient examples of fraud show that the warehouse does not always provide concrete evidence of value.