What is a ‘Purchase Money Security Interest (PMSI)’
A purchase money security interest (PMSI) is a security interest or claim on property that enables a lender who provides financing for the acquisition of goods or equipment to obtain priority ranking ahead of other secured creditors. A purchase money security interest (PMSI) allows lenders to repossess goods that have been purchased with funds borrowed from them if the borrower defaults. A PMSI most often arises in the context of commercial lending. It is also used by some credit card issuers, which allows them to repossess goods purchased by consumers on credit until 100% of the balance associated with such goods has been paid.
BREAKING DOWN ‘Purchase Money Security Interest (PMSI)’
A PMSI most commonly arises in situations where funds are provided by a financier or lender to an entity for the purchase of property such as motor vehicles, where financing is provided at the point of sale.
Uniform Commercial Code
The PMSI concept arose as a means of encouraging companies to finance new equipment or inventory so as to expand their business. While a lender is eligible for a PMSI if it provides a loan for the acquisition of goods and the borrower uses the loan proceeds to acquire the goods, the lender has to follow strict rules that are outlined in Article 9 of the Uniform Commercial Code (UCC) in order to qualify for purchase money priority.
Since a key requirement for a PMSI is for the funds to be used for the purchase of goods (and the burden of such proof falls upon the lender), the best way to satisfy this requirement is for the lender to pay the vendor of the goods directly. This is preferable to the debtor paying for goods and the lender then reimbursing the debtor for the purchase of such goods. In this instance, there is a risk that the PMSI may not be allowed if the court rules that because the lender reimbursed the debtor, it was actually the debtor’s funds and not the lender’s loan that allowed the debtor to acquire rights in the goods. In the case of equipment, the lender must also perfect (i.e. take additional steps with regard to a security interest to make it effective against third parties) its PMSI by filing a UCC financing statement either before or within 20 days after the debtor receives possession of the equipment.
In a PMSI the lender has the right to repossess goods which makes the goods purchased with the loan similar to a type of collateral. If the lender qualifies for a PMSI as detailed in Article 9 of the UCC it can give the lender higher priority ahead of other secured creditors if a default occurs.