By James D. Prendergast
The purpose of this article is to discuss the confusing world of real property fixtures, to understand the commercial law determination of what are fixtures in the first instance, and then, if we figure out what they are, to share how a lender insures its lien priority in fixtures. We will see that this question has taken on a more significant importance with the steady increase in alternative energy projects where the value of the personal property collateral often vastly exceeds the value of the associated real property. Then, again assuming we know what the “stuff” (personal property, a fixture or pure real property) is, we will discuss how the lender insures its lien status in the “stuff” against the claims of other secured creditors and lien creditors, including the bad guy – the hypothetical lien creditor trustee in bankruptcy.
Defining a Fixture
The first question that needs to be answered is “what is a fixture?” Easy question to ask – almost impossible to adequately answer without some attendant risk that you’re wrong. Perhaps the clearest, but not necessarily the most useful, answer was offered by Professor Steve Knippenberg: “You take the world, you shake it, and everything that doesn’t fall off is [a fixture].” My personal favorite answer is to paraphrase Potter Stewart in Jacobellis v. Ohio (1964): A Fixture is like pornography—hard to define, but you know it when you see it. Again, this is truthful, but not helpful. A more fulsome definition comes out of Michigan. In Michigan, as in most states, whether personal property becomes a fixture and thereby part of the realty is determined by a three-part test: (1) is the property annexed or attached to the realty,; (2) is the attached property adapted or applied to the use of the realty, and (3) is it intended that the property will be permanently attached to the realty?
Finally, many authorities take the position that any and all machinery essential to the proper functioning of a plant, mill, or similar manufacturing facility is a fixture, or at least so presumed to be, irrespective of the manner in which it is annexed to the realty and even though it is not attached at all. (Emphasis added) This view is sometimes referred to as the “integrated industrial plant” doctrine and may represent the modern trend of decisions. The problem with this approach is that an equipment lender may need to think twice about its reliance collateral and whether to advance funds or spend a bit more time with its lawyers analyzing whether stand alone, unaffixed (more about this word later) equipment might be considered a real property fixture under a particular state’s law. Such a conclusion might force an analysis of real property encumbrances and the need for additional intercreditor agreements that may prove expensive to obtain.
So what then is a fixture? I have often taken the position, being a personal property lawyer, and a bit tongue in cheek, that the cab of an elevator or the stairs of an escalator might be personal property because such items can be readily removed from the realty without damage to the realty. I am probably wrong in this analysis; I just like to take this position to drive real property lawyers nuts. Personal property so integrated into a building is usually deemed part of the building and not even a fixture, but real property. Personal property so integrated into the real property loses its classification as distinct personal property. The clearest example of this integration of personal property into the realty is paint. Cans of paint at the job site are personal property. However, the paint loses is classification as personal property when applied to a wall. As we will see, even intent of the parties probably will not alter this result. But what about a boat tied to a dock or a really big, heavy boat resting on the ground . Fixtures? And what about a World War II barrage balloon tethered to the ground with a chain designed to deny air space to enemy planes? And then there’s the Macy’s parade.
The problem with a word like “affixed” is that its meaning is remarkably unclear. Black’s Law Dictionary, the source of all matters tertiary, pronounces that “affix” means to “fix or fasten, in any way, to attach physically.” Black’s continues that in the context of real estate, the word means to attach, add to, or fasten upon, permanently (emphasis added). Permanent is then defined as “fixed, continuing, lasting, stable, enduring, abiding, not subject to change.” All this clarity seems to demand a degree of permanence but again fog, not clarity, is the order of the day. Is anything “not subject to change??
So we need a better definition. The Uniform Commercial Code provides the basic definition of what is a fixture because all fixtures begin as “goods.” UCC §9-102(A)(41) provides that "’Fixtures’ means goods that have become so related to particular real property that an interest in them arises under real property law.” This may come as a bit of a surprise to my real estate lawyer friends but the UCC does control the definition of what is a fixture and selects the applicable law concerning fixtures, including the attachment, perfection and priority of liens. However, this is not as helpful as it might seem because the UCC does not determine what “is” real property or when an interest under real property law may arise in goods. The term “affix” is not defined in the UCC and the UCC yields to local real property law for priority disputes involving real property encumbrancers. Back where we started with little additional clarity.
The following chart schematically lays out the continuum from pure real property to pure personal property, through the intervening classifications of “ordinary building materials,” fixtures and trade fixtures.
The figure above spreads out the continuum from real property to personal property with the intermediate realm of fixtures. UCC Article 9 permits the attachment and perfection of security interests in goods, including fixtures, but not “ordinary building materials incorporated into an improvement on land.” “Trade fixtures” is a term used to refer to store shelving and display cases that are not part of the real estate. A fixture, although real property, is defined to be a “good” for purposes of Article 9 (and hence it will fall into one of the four subcategories of “goods”— consumer goods, farm products, inventory or equipment). “Goods” means all things that are moveable when a security interest attaches. “’Goods’ includes (i) fixtures . . . .” ‘Goods’ includes ‘ordinary building materials.’”
In summary, although defined in Article 9, real property law of the relevant state ultimately determines the status of a good as a “fixture”. How affixed is affixed? Local real estate law on this topic is, however, notoriously fuzzy. How firmly affixed to the realty is the good? When is the permanence of affixation enough? What about the intent of the parties? In addition, as discussed above, in some states, anything used to operate an “industrial plant” could be a fixture.
So when is a Good a Fixture?
Courts have generally considered the following factors when determining whether a particular item has become a fixture:
- The manner in which the item is annexed to the underlying realty;
- Its adaptability to the use and purpose for which the realty is used;
- The intention of the party annexing the item;
- The difficulty of removing the item
- The destruction caused to the realty by it’s removal;
- The relationship between the parties
According to Miller & Starr, California Real Estate, the intention of the party annexing the item is the crucial and overriding factor in determining if an item is a fixture and that the other factors are typically used to ascertain the parties’ intentions. The emphasis placed on the parties’ intentions often results in contradictory court decisions for the same item being deemed personalty by one court and realty by another. Miller & Starr further explain that while courts pay homage to the method of annexation as a test for the party’s intent, the true tests for determining the parties’ intentions are the parties’ relationship and the adaptability of the item for use of the realty.
If the dispute is with a third party such as a beneficiary under a deed of trust, the objective factors providing physical evidence of the apparent intention of the owners of the real and personal property are controlling. The use of objective factors to determine the apparent intention of the parties is mentioned in the case of a subsequent mortgagee who may have relied upon the items in question being fixtures.
In the 1952 California Supreme Court case Knell v. Morris, Chief Justice Gibson wrote that determining whether an item is realty or personalty is a question of fact. He explained that various factors must be considered such as “the manner of its annexation, its adaptability to the purpose for which the realty is used and the intention of the party making the annexation.” He further explained that “as to innocent third parties, the intent which controls is that which is reasonably manifested by physical facts and outward appearances, rather than by any express or implied intent of those making the annexation.” He then concluded that it was reasonable to infer that a faulty water heater was attached to the building by gas line and water pipes and therefore was permanently affixed to the realty.
A few other points of clarification from the cases include, using California law as reference: Function alone is not determinative as a test for annexation; attachment of equipment or other personalty to real estate through the use of bolts is not an exclusive test of whether equipment has become a fixture (hence some of the uncertainty with wind turbines); in determining whether affixed personalty is a fixture the intention of the parties is to be given broad significance and is to inferred from the nature of the personalty involved, the relationship between the parties especially the person making the annexation, the personalty involved and the method of annexation and the purpose for which annexation has been made (all of which leads to the ambiguity of the wind turbine); and, as between private parties, the intent of the parties is controlling. Further, a building need not be physically anchored to the real property to be considered a fixture or real property. The building can be considered real property even if it is “secured” to the ground by gravity alone! But then, gasoline and kerosene pumps on filling station property readily unscrewed from their connection with underground tanks and an automobile hoist which, though resting on a concrete footing, was not attached to the footing and could be removed with little damage, were considered by the court to be personal property and not included in the “improvements pertaining to the realty.” Finally, summarizing the state of the law of fixtures, under California law, and probably the law of most jurisdictions, classification of an object as either personal property or as a fixture is not a factual description of the object but rather a statement of a legal conclusion or result as to entitlement to the object between contestants.
Just Personal Property or a Fixture?
Therefore, “what is a fixture” and what we have gleaned so far. Article 9 looks to local (non-A-9) law for the proper characterization. In general, the characterization turns on the intent of the parties, whether or not viewed through the lens of reasonableness. Except in the clearest cases (i.e., a building erected on a "permanent" foundation pursuant to applicable building codes, permits, and the like, and replacement windows, HVAC, or roofing material installed therein), the intent of the parties is often difficult to decide. We need to always remember, however, that the world has no shortage of bankruptcy cases (and realty transfer tax collection actions by revenue-hungry municipalities) in which huge (and valuable) equipment whose removal would wreak havoc on a structure is variously found to be either fixtures or not.
Therefore, in conclusion, we can give a very general framework within which to determine if “affixed” equipment is a fixture. We need to look at the method of attachment: Is the equipment permanently affixed, bearing in mind that “permanently” in this context may be in the eye of the beholder? Is the equipment adaptable to the use and purpose of the real property on which it is affixed. Is the equipment usable at other locations, such as a wind turbine, which can be moved anywhere there is sufficient wind? Is the equipment in question essential to the ordinary use of real property, such as a roof-mounted solar-panel system, providing power to the building upon which it sits? But maybe not a wind turbine on otherwise vacant land providing power to the grid. Finally, and most important, what is the annexing party’s intent? In many states, this last point is dispositive at least between the parties for most energy-related acilities.
So let’s consider the following example:
- The turbine, the high-dollar item in this facility, is almost always personal property!
- The third and further removable sections of the tower may, as affixation to the realty gets more distal, be personal property;
- The second section of the tower, as affixed to the lower section, and again depending on the intent of the parties for removal upon termination of the ground lease, may be a fixture or personal property;
- The first section of tower, depending on intent of the parties, is probably a fixture, as it is directly affixed to the realty:
- The cement pad to which the first tower section is affixed is probably real property.
I am not sure there is a court in the land that would consider the turbine engine, composed of a collection of parts that are periodically replaced through normal wear and tear of the turbine and the blades, a real property fixture. Rather, the nature of the equipment and its distal affixation to the realty through a number of tower sections that can be removed through un-tightening a few bolts, should lead to the conclusion that the turbine is probably personal property and not a fixture, something like the Macy’s parade balloon. Although an opposing party could assert the concept of permanent affixation, the parties’ intention will probably be dispositive as to the property classification of the turbine. More likely than not, the ground lease agreement between farmer Jones and the power generation company provides that in the event of a termination of the ground lease, for whatever reason, the power generating company can (and in some cases must) remove the turbine and tower from the realty. Further, the parties to the ground lease typically agree that for all purposes the tower and turbine shall be deemed to be personal property not subject to any real property encumbrance.
All of this highlights the structural confusion of the law of fixtures, especially as applied to alternative energy facilities. California Civil Code section 660, for example, in pertinent part, defines the affixation of a fixture: “A thing is deemed to be affixed to land when it is attached to it … or embedded in it, … or permanently attached to what is thus permanent, as by means of cement, plaster, nails, bolts or screws; except that for the purpose of sale, emblements, industrial growing crops and things attached to or forming part of the land, which are agreed to be severed before sale or under the contract of sale, shall be treated as goods and be governed by the provisions of the title of this code regulating the sales of goods.” So maybe the outer casing of the turbine is a fixture, as attached through a series of bolts, but again what about the components that are set inside and replaced on a periodic basis through preventive maintenance?
So, now that that is clear, it is time for a quiz! What about solar panels attached to a framing by only a wing nut? Is a wing nut a form of a bolt? However, does the wing nut affix the solar panels to the real property or merely stop the panels from sliding out onto the ground? The panels are not very heavy; does gravity apply? The panels are periodically replaced as intended when installed due to ordinary wear and tear with NO harm to the realty. And the panels are very expensive, exceeding in value the cost of the framing. So, do the panels retain their characterization as personalty or do they become fixtures when slid into a frame and held in place by a wing nut? All of this could be really important if the lender financing the solar facility only filed a real property mortgage and the fight is with the bankruptcy trustee of the borrower over whether the solar panels are fixtures or merely personal property as to which an interest therein cannot be perfected through the real property records. There are two lien perfection regimes involved in this discussion and perhaps an example with highlight the issues.
Two Places to Perfect Your Lien?
The same piece of machinery can be merely personal property with attachment, perfection and priority of a security interest therein determined solely by Article 9 rules. The same item of equipment could also, at the same time, be “affixed” to the realty in such a way as to allow rights to arise therein under real property law – now a fixture. This would bring into play a priority contest between a real property encumbrancer and a personal property lien holder and the priority scheme under real property law would control subject to the priority rules set out in Article 9 for fixtures.
For perfection purposes under Article 9, financing statement filings against inventory and equipment are to be made in the same jurisdiction as filings against accounts and general intangibles, and such jurisdiction is determined based on the location of the debtor instead of the location of the inventory or equipment. In the case of a registered entity, such as a corporation, the location of the debtor is the jurisdiction where the debtor is organized. Because of the foregoing, the governing law will be different depending on whether the secured party is perfecting its security interest in fixtures by filing a local fixture filing in the real property records or by filing a financing statement in the UCC central filing office against goods of the type involved.
Under Article 9, the law governing perfection and priority is determined in accordance with §9-301. With respect to fixtures, the local law of the jurisdiction where the fixtures are located will govern perfection of a security interest therein by filing a fixture filing, and will also govern the effect of perfection or non-perfection and the priority of non-possessory security interests therein. While usually in the form of a financing statement, a fixture filing is not a financing statement for purposes of Article 9.
However, in the case of a security interest in fixtures that is perfected by the filing of a financing statement that is not a fixture filing, the local law of the jurisdiction where the debtor is located will govern perfection of a such a security interest, while the local law of the jurisdiction where the fixture is located will govern the effect of perfection or non-perfection and priority of a non-possessory security interest therein. For example, perfection of a security interest in fixtures located in Arizona and owned by a Delaware corporation would be governed by the law of Delaware. Although Delaware law would send one to the filing office in Arizona for the place to file a financing statement as a fixture filing, Delaware law would not take account of local, non-uniform, real property recording and filing requirements that Arizona law might impose.
Both methods (central filing of a financing statement and local filing of a fixture filing) suffice to perfect the security interest, but they may have different priority consequences.:
- Both methods (a centrally filed financing statement against the equipment solely as personal property and a local fixture filing against the good as a fixture) suffice to defeat a subsequent lien creditor, and hence also suffice to defeat the strong-arm power of the debtor’s bankruptcy trustee under BC 544(a)(1).
- Both methods establish priority against a competing Article 9 secured party (“SP”) per the usual SP vs. SP rules.
- However, if the competing claimant is someone who is claiming through the real estate—i.e., the competing claimant is an owner (other than the debtor) or an encumbrancer of the real estate (“RE Claimant,” for short)—SP may be able to obtain priority over the RE Claimant only if SP has made a fixture filing.
So let’s consider a priority contest between a SP and a RE Claimant in a fixture (§9-344© through (h)). The baseline rule is that the RE Claimant has priority over SP, unless an exception applies. §9-334©:
Key Exception I : SP has priority over RE Claimant in a fixture in the following circumstances:
- “First to file in the RE records”: SP has priority if SP made a fixture filing before the RE Claimant’s interest appears in the real estate records. §9-334€(1);
- Applies only if debtor has an interest of record in the real estate or is in possession;
- If RE Claimant has priority over SP under this rule, and the RE Claimant later sells or encumbers its interest in the real estate, the RE Claimant’s successor in title also has priority (even though the successor’s interest will appear of record only after SP’s filing). (This is the force of clause (B) of (e)(1) of §9-334. See Official Comment 6).
Key Exception II : SP has priority over RE Claimant in a fixture in the following circumstances:
- PMSI (Purchase Money Security Interest; defined in §9-103). SP has priority if SP has a PMSI, makes a timely fixture filing, and the RE Claimant’s interest in the real estate arose before the goods became a fixture. §9-334(d);
- This PMSI exception does not apply against a “construction mortgage.” §9-334(h).
Key Exception III: SP has priority over RE Claimant in a fixture in the following circumstances:
- Certain “non-fixture fixtures”. SP has priority if the “fixture” is a readily removable good of a specified type, and the security interest is perfected by any method (i.e., including ordinary filing or automatic perfection) before the good became a fixture. §9-334(e)(2)
- RE Claimant rolls over and plays dead. SP has priority if the RE Claimant has consented to the security interest, or if the debtor has a right to remove the good as against the RE Claimant. §9-334(f).
Assuming the SP has appropriately filed a fixture filing and has priority over all owners and encumbrancers of the real property, the SP can remove the fixture from the underlying realty after default in the following circumstances.
- If a security agreement covers goods that are or become fixtures, a secured party may proceed under Article 9 or in accordance with the rights and remedies with respect to real property. §9-604;
- If a secured party holding a security interest in fixtures has priority over all owners and encumbrancers of the real property, then the secured party, after default, may remove the collateral from the real property. §9-604©;
- A secured party that removes collateral shall promptly reimburse any encumbrancer or owner of the real property other than the debtor for the cost and repair of any physical injury caused by the removal;
- The secured party need not reimburse the encumbrancer or owner for any diminution in value of the real property caused by the absence of the goods removed or by the necessity of replacing them; and
- A person entitled to reimbursement may refuse permission to remove until the secured party gives adequate assurance for the performance of the obligation to reimburse. §9-604(d).
Official Comment 3 to §9-604 states that subsection (b) “also serves to overrule cases holding that a secured party’s only remedy after default is the removal of the fixtures from the real property.”
Given what we have discussed to this point, there are clear advantages in perfecting one’s security interest in goods that may become fixtures both centrally and in the appropriate real estate records. A secured party who perfects a security interest in fixtures only by filing a financing statement with the Secretary of State will not benefit from many of the special priority rules outlined above. For example, such a perfected security interest will be junior not only to prior recorded real property interests, but also subsequent recorded real property interests. A secured party who perfects a security interest in fixtures only by filing a fixture filing in the real property records takes the risk that if the goods are not “fixtures,” then its security interest will be unperfected. Finally, a secured party who is taking a security interest in fixtures under Article 9 should consider not only searching the real property records for prior fixture filings and prior real property encumbrances, but also conducting a UCC search of the records of the Secretary of State to determine whether there are prior filings against fixtures which would have priority under Article 9 (if determined to be personalty).
A few final comments are in order before we discuss specific examples of the difficulty of determining what a fixture is even if we know the rules to apply. Under §9-502(c), a record of a mortgage is effective as a financing statement filed as a fixture filing only if the record indicates the goods that it covers, the goods are or are to become fixtures related to the real property described in the record, the record satisfies the requirements of a financing statement under Article 9 other than an indication that it is to be filed in the real property records, and the record is duly recorded. Official Comment 6 to §9-502 states:”the fact of filing [a precautionary fixture filing] should not be a factor in the determination whether goods are fixtures.”
The general rule is that a financing statement is effective for a period of 5 years after the date of filing. If a debtor is a transmitting utility and a filed financing statement so indicates, the financing statement is effective until a termination statement is filed. A record of mortgage that is effective as a financing statement filed as a fixture filing remains effective as a financing statement filed as a fixture filing until the mortgage is released or satisfied of record or its effectiveness otherwise terminates as to the real property.
A Clarifying Example
Dowel Manufacturing Company, a Delaware corporation, owns and operates a large factory in Rantoul, Illinois. Production depends on a wide variety of machinery -- power shafts built into the walls’ heavy stamping presses held in place by their own weight; power lathes bolted to the floor; machinery on wheels. In 1999, when Dowel built the factory, it obtained a $3,000,000 loan from Firstbank; payments were to be amortized over a period of 20 years. To secure the loan, Dowell executed and delivered to Firstbank a mortgage covering the land and buildings that comprise the factory, with the usual clauses bringing within the mortgage all “appurtenances and fixtures,” then owned or thereafter acquired. Firstbank properly recorded the mortgage. In 2006, Dowel Manufacturing obtained a loan from Secondbank. and the borrowed funds were used to purchase a wide range of factory equipment, including a stamping press built into the walls of the building, power lathes bolted to the floor and robotic electric carts that carry materials from one machine to another. Dowel executed and delivered to Secondbank a security agreement covering this equipment. Before the equipment arrived, Secondbank filed a “fixture filing” in the local office where mortgages are recorded. Dowel now is in default to Firstbank and Secondbank and has filed a petition under the Bankruptcy Code.
- Is Secondbank’s security interest in the new equipment as personal property effective in bankruptcy? No, filed in wrong place. Should have filed with the Delaware Secretary of State. If item of factory equipment is a fixture, Secondbank is perfected?
- Who has priority in the new equipment, Firstbank (mortgage) or Secondbank (PMSI and fixture filing)? If robot cart is a fixture, Firstbank’s mortgage lien runs to it. However, Secondbank (SP) has a security interest, apparently a PMSI, perfected by a fixture filing. Therefore, Secondbank wins. (PMSI exception subsection (d) of §9-334 of Article 9 of the UCC). If the robot cart is not a fixture, Firstbank has no lien on it: not picked up by the mortgage. Secondbank has a security interest in the cart, but unperfected, since only a fixture filing. The result: Secondbank loses to trustee in bankruptcy.
- Suppose that in July 2001, before Secondbank (PMSI and fixture filing) came on the scene, Debtor granted a security interest in all of its equipment, existing and after acquired, to Lender, who filed with Secretary of State of Delaware. What does Lender have in the equipment? The Lender has a perfected security interest by filing its financing statement with Delaware, debtor location, under the normal Article 9 rule, §9-301(1). Where does Secondbank make its fixture filing? Illinois, location of goods, §9-301(3)(A). What state’s law governs priority between the two? Illinois, location of goods. §9-301(3)(C). Illinois law governs whether the goods are or are not fixtures. If the equipment at issue is, in fact, a fixture, Secondbank as PMSI has priority. If not a fixture, Lender has priority; perfected in Delaware. Secondbank has unperfected PMSI.
- What should Secondbank have done when it made its loan? Two things: (i) ordinary filing in Delaware Secretary of State to perfect in event the goods are not fixtures – beat the trustee in bankruptcy, and beat competing Article 9 secured parties like Lender; and (ii) fixture filing in real estate records of county where the goods are located in Illinois, to beat real estate claimants like Firstbank – take advantage of the PMSI priority in §9-334(d).
Therefore, the first problem is to decide whether the equipment is personalty or a fixture using the (at best) confusing fixture classification rules. The next issue is where to file to perfect your lien or security interest. Obviously, the secured party must answer the first question correctly in order to correctly answer the second question. However, if you are wrong with the first question (personalty or fixture), you could be really, really wrong. Rather than having the status of a senior secured creditor in the solar panel facility or the wind turbines in the bankruptcy of the borrower, you could have the wonderful status of a general unsecured creditor subordinate to the trustee and all secured creditors and administrative claimants.
The Insurance Solution
One solution to this dilemma of trying to determine when an item of equipment is merely personal property or a fixture is to rely on title insurance. However, the issue here is what kind of “title” insurance. Your first reaction is probably “land title insurance.” Your reaction is correct but only up to a point—and the point is again: What is the equipment? Is it personal property or a fixture? Land title insurance doesn’t answer this fundamental question, but ultimately begs the question. First, a basic, unendorsed land title insurance policy by its terms only covers claims involving real property and fixtures. Therefore, if the solar panels are personalty, the land title policy provides no coverage at all. You may then ask whether you can endorse the coverage offered by the land title policy to cover the equipment in the event it is determined to be personalty, usually by a bankruptcy judge not generally known to be pro-lender.
Following is an endorsement offered by the American Land Title Association, number 31-06 (Severable Improvements), adopted 2-3-11, that attempts to provide some coverage in this area.