In-Transit Inventory and Electronic Bills of Lading: A Practical Guide for ABL Lenders

ABL lenders, including non-bank lenders in particular, are under increasing pressure from borrowers and sponsors to lend against asset categories that have traditionally been excluded from the borrowing base. In-transit inventory (goods moving from a third-party seller to the borrower, between warehouse locations, or between third parties) is one common example of such an asset class. Lending against in-transit inventory presents a distinct set of legal, structural, and practical challenges that lenders must navigate carefully. This article provides an overview of the key issues, with a particular focus on the growing use of electronic bills of lading and its impact on a lender’s security position.

Obtaining a Security Interest: The Basics

Obtaining a security interest in in-transit inventory is, in principle, straightforward. If the UCC Article 9 is determined to govern the creation and perfection of the security interest, the standard requirements apply: an authenticated security agreement, value given by the secured party, and rights of the debtor in the collateral. As for perfection under Article 9, a UCC-1 financing statement filed against the debtor in the correct filing office with a collateral description covering “inventory” will perfect the lender’s security interest in in-transit inventory. This filing should be in place before any goods enter the supply chain.

While a necessary first step, a perfected security interest obtained by filing alone leaves the lender exposed. The largest risk comes from the due-negotiation priority override under UCC § 7-502. If a person obtains a negotiable document of title covering the borrower’s in-transit inventory and takes such document by due negotiation, then that person’s title to the underlying goods will typically be superior to a senior secured lender who has only perfected its security interest by UCC-1 filing. The nuances of this risk and the requirements of Article 7 are covered in detail below.

Beyond priority, a lender with only a UCC-1 filing has no direct relationship with the carrier transporting the goods. The carrier’s delivery obligations run only to the holder under the document of title. Without privity, a lender relying solely on a UCC-1 filing for perfection cannot instruct the carrier to redirect or stop delivery, and such a lender also has no practical mechanism to prevent the borrower from diverting goods in transit. Additionally, in situations where the goods are being held on a ship in international waters or in a non-US port, there are questions that arise with respect to the choice of law that governs with respect to a lender’s security interest. Specifically, maritime law, including applicable international conventions (such as the Hague-Visby Rules or the Rotterdam Rules) and the law of the vessel’s flag state, will typically govern the carrier’s obligations and the rights of bill of lading holders for goods at sea. As a result, even where a lender has perfected its security interest by filing under Article 9, the Article 7 protections, including due-negotiation priority, the carrier’s delivery obligations, and the ability to redirect goods in transit, may not apply to goods aboard a foreign-flagged vessel in international waters. Lenders should analyze the governing law of the underlying bill of lading and the flag state of the carrying vessel, and should consider whether additional protections under applicable maritime law or international conventions are necessary to supplement their UCC-based security interest.

Negotiable Documents of Title

First, in order for the Article 7 framework to apply, along with the accompanying protections and enhancements for a lender, a record must qualify as a document of title. UCC § 1-201 defines a “document of title” as a record that, in the regular course of business or financing, is treated as adequately evidencing that the person in possession or control of the record is entitled to receive, control, hold, and dispose of the record and the goods it covers. Documents of title can include bills of lading, dock warrants, dock receipts, warehouse receipts, and orders for delivery of goods. A carrier’s booking confirmation, a shipment-tracking record, a logistics entry, or an internal warehouse ledger notation does not qualify as a document of title solely by virtue of referencing specific goods. Instead, the record must have an entitlement function and must be understood to confer specific rights on the holder.

Distinguishing whether a document of title is “negotiable” is equally important. Under UCC § 7-104, a document of title is negotiable if by its terms the goods are to be delivered “to bearer” or “to the order of” a named person. These are the operative words and there are no substitutes.

Perfection by Possession: Tangible Documents of Title

Under UCC § 9-313, a secured party may perfect a security interest in negotiable documents of title by possession. Possession of a negotiable document of title provides a stronger position than perfection by UCC-1 filing alone because the lender obtains both the benefits of Article 9 and Article 7.

The simplest method is for the lender to hold the original document itself. Alternatively, and more commonly, a qualifying third party can hold the original document on the lender’s behalf. Under UCC § 9-313(c), the lender is deemed to have possession when a person other than the debtor authenticates a record acknowledging that it holds, or will hold, possession of the document for the secured party’s benefit. Common third-party holders include collateral agents, custodians, customs brokers, freight forwarders, and banks acting as document-handling agents. It is important to note, however, that, the debtor itself cannot serve as the holder.

Lenders can mitigate these risks by entering into an effective freight forwarder agreement or carrier agreement with the party that holds the documents of title and controls the goods in transit. Given the importance of third-party acknowledgment, standalone letters providing UCC § 9-313(c) acknowledgments are common in the industry, but a comprehensive freight forwarder or carrier agreement provides significantly stronger protections. The agreement should require the freight forwarder or carrier to hold and control negotiable documents of title on behalf of the lender or its agent; prohibit the release of the documents or goods without the lender’s consent; subordinate any possessory liens held by the freight forwarder or carrier; require the freight forwarder or carrier to follow the lender’s instructions upon a borrower default, including redirecting or stopping delivery of the goods; and require the freight forwarder or carrier to issue bills of lading to the order of the lender or its agent.

Electronic Bills of Lading

Over the last few decades, the market has been moving steadily away from tangible bills of lading in favor of electronic alternatives. Electronic documents eliminate the risk of lost originals, reduce documentary delays and associated costs, and streamline processes. For ABL lenders, however, electronic bills of lading introduce additional complexity.

Under Article 7, a document is negotiated by “delivery” to another person. Delivery of an electronic document simply means voluntary transfer of control. The entire negotiation process for electronic bills of lading is therefore driven by the UCC § 7-106 control framework below.

For electronic documents, perfection by possession is replaced by perfection by control. Under UCC § 7-106, a person has control of an electronic document of title if a system employed for evidencing the transfer of interests in the electronic document “…reliably establishes that person as the person to which the electronic document was issued or transferred.” This is a functional test, and it does not name any particular platform or technology.

Section 7-106 sets out indicators of reliability, including the following:

• A single authoritative copy of the electronic document exists;
• That authoritative copy identifies the person asserting control as the person to whom the document was issued or transferred;
• The authoritative copy is communicated to and maintained by that person or its designated custodian;
• Copies or revisions that change the identified controlling person can be made only with that person’s consent; and
• Each copy of the authoritative copy is readily identifiable as a copy that is or is not the authoritative copy.

Electronic Platforms (Practical Application of Article 7)

Fortunately for ABL lenders, several third-party platforms have been developed to create electronic records that function as bills of lading. These systems are structured to satisfy the UCC § 7-106 control requirements but lenders should still carefully analyze such platforms before agreeing to their use. Examples of systems and standards designed to support conforming electronic bills of lading include BOLERO (Bolero International), essDOCS (now part of the CargoX ecosystem), edoxOnline, TradeLens (developed by Maersk and IBM, although it ceased operations in 2022), CargoX, and standards developed by the Digital Container Shipping Association (DCSA). Although these platforms and standards are designed to support compliance with the control requirements, lenders should independently verify that the specific platform, implementation, and transaction satisfy UCC § 7-106.

In evaluating any such platform, an ABL lender should be satisfied that the following questions are satisfactory answered to protect its interests:

• Does the carrier issue an Article 7 bill of lading through the platform? The carrier (or other bailee) must acknowledge possession of goods and contract to deliver them. Merely facilitating communication or simply tracking shipments without the carrier issuing a document that embodies a delivery obligation is insufficient.
• Is the document on the platform negotiable? The terms must provide for delivery to bearer or to the order of a named person. Some electronic platforms default to nonnegotiable form unless the user specifically selects negotiable terms.
• Does the platform satisfy the UCC § 7-106 control test? A single authoritative copy must exist, the controlling person must be reliably identified, changes require consent, and copies must be identifiable as authorized or unauthorized.

If an electronic bill of lading does not satisfy the Article 7 requirements, the lender’s enhanced protections fall away and perfection reverts to the UCC-1 filing. That UCC-1 filing will remain effective as a matter of Article 9 but the lender loses the Article 7 benefits: no due-negotiation priority protection, no direct right to delivery from the carrier, diminished ability to redirect or stop delivery in transit, and a significantly weaker enforcement posture upon default.

Practical Risk Mitigation for ABL Lenders

Given the legal complexity and practical risks outlined above, ABL lenders should adopt a layered strategy that reduces risk where possible and reinforces their security interest.

First, lenders should not lose sight of the basics. The underlying security agreement’s collateral description must be broad enough to capture inventory, goods, documents, documents of title, bills of lading, general intangibles, and proceeds. This must be coupled with an effective UCC-1 financing statement.

Negotiable documents of title will not always be available, and even where they are, lenders should look to supplement them with contractual protections up and down the supply chain with customs broker and carrier agreements, collateral access agreements, bailee letters, and insurance arrangements. All such agreements can provide practical enforcement mechanisms independent of the Article 7 framework. In particular, a well-drafted freight forwarder or carrier agreement can serve as the lender’s primary contractual tool for maintaining control over negotiable documents of title. As noted above, these agreements effectively bridge the gap between the lender’s Article 9 security interest and the Article 7 framework by giving the lender contractual privity with the party that controls the physical movement of the goods and the issuance of documents of title.

Finally, the borrowing base itself should be structured with the borrower’s specific supply chain in mind. Eligibility criteria should reflect the actual risks presented. Advance rates will necessarily need to be different for in-transit inventory than for inventory held in a warehouse. Reserves may be needed to mitigate risks associated with freight costs, customs duties, carrier and broker possessory liens, and other uncertainty.

Lending against in-transit inventory requires ABL lenders to look beyond a UCC-1 filing to secure the enhanced protections of the Article 7 framework, whether through physical possession of negotiable documents of title or verified control of electronic bills of lading under UCC § 7-106, while reinforcing those protections with contractual arrangements throughout the supply chain. A layered strategy combining legal perfection, platform diligence, carrier agreements, and tailored borrowing base mechanics will provide the strongest possible security position with respect to in-transit inventory.