After acquired clause: Meaning, Criticisms & Real-World Uses

What Is After Acquired Clause?

An after acquired clause is a contractual provision, commonly found in a loan agreement or security agreement, stipulating that any asset the borrower obtains after the agreement is signed will automatically become part of the collateral for a secured loan. This clause grants the lender a security interest in these newly acquired assets without the need for additional documentation or perfection actions beyond the initial filing. It is a fundamental concept within secured transactions, ensuring that a lender's collateral base remains robust even as a business's asset composition changes over time.

History and Origin

The concept of an after acquired clause has deep roots in commercial law, evolving significantly with the development of modern secured lending practices. Historically, securing debt against future assets was often complex or even legally impossible under common law, which typically required the borrower to possess the collateral at the time the security interest was created. This posed challenges for businesses with circulating assets like inventory or accounts receivable, as their collateral base would constantly change.

The widespread adoption of the Uniform Commercial Code (UCC) in the United States, particularly Article 9 concerning Secured Transactions, revolutionized this aspect of commercial law. The UCC explicitly validates after acquired clauses, making it possible for a security interest to attach to property that a debtor acquires in the future. This legal framework has been crucial for facilitating modern commercial finance by allowing lenders to secure their interests in a dynamic business environment, ensuring that as a borrower's asset base grows, so too does the pool of collateral backing the debt. The evolution of secured debt arrangements, including the use of after acquired clauses, has been central to the expansion of commercial credit and the efficient allocation of capital.³⁷

Key Takeaways

An after acquired clause automatically extends a lender's security interest to assets obtained by the borrower after a loan agreement is executed.
This provision is vital in secured lending, especially for businesses with fluctuating or growing asset bases like inventory and accounts receivable.
It is explicitly permitted and governed by Article 9 of the Uniform Commercial Code in the United States.
The clause helps protect lenders' interests by maintaining the value and breadth of their collateral over the loan term.
Without such clauses, lenders would need to execute new security agreements each time a borrower acquired a new asset, which would be impractical.

Interpreting the After Acquired Clause

Interpreting an after acquired clause involves understanding its scope and implications for both the borrower and the lender. The clause typically specifies the types of assets that will be covered (e.g., all equipment, all inventory, all accounts, or all tangible and intangible assets). It means that if a business takes out a loan secured by its current inventory and equipment, any new inventory purchased or equipment acquired thereafter automatically falls under the existing security interest.

For the lender, this clause provides continuous protection by expanding the pool of collateral as the borrower's operations grow. This reduces the risk of insufficient collateral in case of a default. For the borrower, it allows for greater flexibility in using future assets to secure financing without requiring constant renegotiation or amendment of loan documents. However, it also means that the borrower's future assets are encumbered, potentially limiting their ability to use those assets to obtain additional, separate financing from other lenders without the existing lender's consent.

Hypothetical Example

Consider "Alpha Manufacturing," a company seeking a $5 million secured loan from Big Bank to expand operations. The loan agreement includes an after acquired clause. At the time of the agreement, Alpha's existing collateral includes $3 million in machinery and $2 million in raw inventory.

Six months later, Alpha Manufacturing uses part of the loan proceeds to purchase $1 million worth of new, advanced machinery and acquires an additional $500,000 in raw materials. Due to the after acquired clause in their loan agreement, Big Bank's security interest automatically extends to these newly acquired assets. This means that Alpha's total collateral now includes the original $5 million in assets plus the $1.5 million in new machinery and inventory, totaling $6.5 million, all without needing to amend the original security agreement or file new documentation specifically for these new assets.

Practical Applications

After acquired clauses are ubiquitous in commercial finance, appearing in various types of lending and financing arrangements. Their primary application is in situations where the collateral base is dynamic or expected to grow over time.

Revolving Credit Facilities: Businesses often use revolving lines of credit secured by current assets like inventory and accounts receivable. An after acquired clause ensures that newly generated receivables or newly acquired inventory automatically become part of the collateral, allowing the loan amount to fluctuate with the value of the collateral.
Equipment Financing: When a company finances equipment, the loan may be secured not only by the purchased equipment but also by any future equipment acquisitions. This provides the lender with broader protection as the company upgrades or expands its operational assets.
Corporate Bonds and Debentures: Many corporate bonds are secured by the issuer's assets. An after acquired clause in the bond indenture ensures that newly acquired assets also serve as collateral for the bondholders, enhancing the security of their investment. Public companies often file these agreements as exhibits with the SEC.³⁶
Debtor-in-Possession (DIP) Financing: In bankruptcy proceedings, DIP financing, which allows a bankrupt company to continue operating, often includes after acquired clauses. These clauses ensure that new assets acquired by the debtor during the bankruptcy process become collateral for the DIP lenders, making such financing more attractive.³⁵ Lenders will also ensure proper perfection of their security interest in these newly acquired assets.

Limitations and Criticisms

While highly beneficial for lenders, after acquired clauses do present certain limitations and can draw criticism, particularly concerning their impact on a borrower's financial flexibility.

One primary limitation is the potential for a "floating lien" to hinder a borrower's ability to secure additional financing. Because the after acquired clause grants a broad security interest over future assets, it can be challenging for a borrower to offer unencumbered collateral to a new lender. This can restrict a company's access to new credit lines or capital, especially if the original loan agreement contains restrictive covenants.

Furthermore, in instances of bankruptcy, the reach of an after acquired clause can be a point of contention. While generally enforceable, there are specific rules and potential limitations under bankruptcy law that can affect how a security interest in after-acquired property is treated, particularly concerning preferential transfers or the creation of new liens post-petition. The value and liquidity of the asset types covered by the clause can also be a point of criticism, as illiquid or highly specific assets may not provide the desired level of security in a default scenario.

After acquired clause vs. Future advance clause

The after acquired clause and the future advance clause are both common provisions in lending agreements, but they serve distinct purposes. While often found together, understanding their individual functions is crucial.

An after acquired clause determines what assets will serve as collateral for a loan. It states that any assets the borrower acquires after the initial loan agreement is signed will automatically be included in the pool of collateral for the existing debt. This ensures the lender's security interest "floats" over a growing or changing asset base.

A future advance clause, on the other hand, determines what debt will be secured by the existing collateral. It stipulates that the collateral pledged for an initial loan will also secure any future loans or credit extended by the same lender to the borrower. This allows for subsequent advances of credit without requiring new security agreements for the same collateral.

In essence, the after acquired clause expands the collateral base, while the future advance clause expands the debt secured by that base. Both clauses facilitate ongoing financial relationships by reducing the need for continuous paperwork and re-establishing security.

FAQs

Q: Why do lenders require an after acquired clause?

A: Lenders require an after acquired clause to protect their security interest in a borrower's assets. For businesses with dynamic inventory, accounts receivable, or evolving equipment, this clause ensures that new assets acquired by the borrower automatically become part of the collateral for the existing loan. This maintains the value and breadth of the collateral throughout the loan term, reducing the lender's risk of loss in case of a default.

Q: Is an after acquired clause always enforceable?

A: Generally, yes, an after acquired clause is enforceable under Article 9 of the Uniform Commercial Code in the U.S. However, there can be specific exceptions or limitations, particularly in bankruptcy proceedings, where certain rules may affect how a security interest in after-acquired property is treated. Proper filing of a financing statement is crucial for the perfection and enforceability of the security interest against third parties.

Q: Can an after acquired clause cover all types of assets?

A: An after acquired clause can cover most types of business assets, including tangible assets like inventory and equipment, and intangible assets such as accounts receivable, intellectual property, and general intangibles. The specific assets covered will be detailed in the loan agreement or security agreement. Certain assets, such as consumer goods acquired for personal use, may have different rules or be excluded by law, but for commercial lending, the scope can be very broad.

Q: How does an after acquired clause impact a business's flexibility?

A: While beneficial for obtaining initial financing, an after acquired clause can impact a business's future financial flexibility. Since it grants a security interest in all future-acquired assets (of the specified types), it can limit the business's ability to use those new assets as collateral for additional loans from other lenders. This might require negotiating with the original lender for waivers or subordinations if new, separate financing is needed.

¹, ² ³ ⁴ ⁵, ⁶ ⁷ ⁸ ⁹, ¹⁰ ¹¹, ¹² ¹³, ¹⁴ ¹⁵ ¹⁶, ¹⁷ ¹⁸, ¹⁹ ²⁰ ²¹ ²², ²³ ²⁴[²⁵](https://www.vedderprice.com/-/media/files/vedder-thinking/publications/2003/03/debtorinpossession-financing/files/debtorinpossession-financing/fileattachment/debtorinp[³³](https://www.law.cornell.edu/ucc/9/9-204), ³⁴ossession-financing.pdf?rev=b9736f83e183410281741929ee0d3239)²⁶, ²⁷ ²⁸, ²⁹ ³⁰, ³¹ ³²