SECURITY INTEREST IN COMMERCIAL TORT CLAIM IS SUBJECT TO THE INTEREST OF PRIOR SECURED CREDITOR EVEN AFTER FORECLOSURE OF ITS OTHER COLLATERAL

An interesting case comes out of the Eighth Circuit Court of Appeals concerning competing interest in collateral after the senior secured creditor foreclosed upon the debtor’s assets securing the loan made by it.  Bayer CropScience, LLC v. Stearns Bank Nat’l Ass’n 2016 WL 5030340 (8th Cir. 2016).

In 2010, Stearns Bank foreclosed its 2002 Deed of Trust given as security for loans it made to Texana Rice Mill and Texana Rice Inc. (collectively, “Texana”).  After the foreclosure Stearns Bank was still owed nearly $4 million.   In 2007, Texana granted Amegy Bank a security interest in a tort claim Texana was pursuing against Bayer CropScience, LLC in order to secure a $2 million unsecured loan that had defaulted.  The commercial tort claim was for damages Bayer CropScience caused to Texana’s property and crops.  In 2012, after Texana and Bayer reached a settlement, Stearns Bank applied for Writs of Garnishment and served them upon Bayer.  Bayer brought an interpleader action to determine whether Stearns Bank or Amegy Bank was entitled to the proceeds of the tort claim.

Under UCC 9-204, an after acquired provision in a granting clause does not cover a commercial tort claim.  In addition, 9-108(e) requires that the commercial tort claim be specifically described.  Thus, a commercial tort claim that arises after the loan has been documented may not be covered by the loan documents.  Amegy Bank was granted a specific interest in the tort claim against Bayer CropScience.

UCC 9-617 provides “A secured party’s disposition of collateral after default: (1) transfers to a transferee for value all of the debtor’s rights in the collateral; (2) discharges the security interest under which the disposition is made; and (3) discharges any subordinate security interest or other subordinate lien.

Amegy Bank claimed and the court below ruled that under UCC 9-617 when Stearns Bank foreclosed on its collateral its security interest was discharged – even though after the disposition of the collateral Stearns was still owed nearly $4 million.

The Eighth Circuit  considered whether Stearns Bank had a superior security interest in the settlement funds to the extent they were for damages to its original collateral.  First, it determined that pursuant to UCC § 9-617, a secured creditor’s foreclosure on the debtor’s collateral does not discharge an otherwise valid security interest in the proceeds of that collateral.  Next, the Court determined that the heightened identification requirements for encumbering commercial tort claims under UCC § 9-108 means that the drafters “intended for the proceeds of a commercial tort claim to be excluded from an after-acquired general intangible clause.”  Finally, the Court held that while Stearns had no interest in the proceeds as a “general intangible” it still had a superior interest in the proceeds as original collateral pursuant to the terms of its security agreement, and that this interest  was “not displaced simply because damage to that collateral [gave] rise to a subsequent commercial tort claim.”

It is noteworthy, however, that in 2011, the First Circuit determined (In re: American Cartage, Inc. 656 F3d 82) that a commercial tort claim for damages resulting from conversion of assets, interference with contractual relationships and breach of fiduciary duties was not proceeds of the secured creditor’s collateral but, instead, was an asset of the Chapter 7 estate.

            The good news is that the Eighth Circuit correctly protected the secured party’s rights in remaining collateral after disposition under 9-617.

            The caveat, however, is to beware when taking a specific interest in a commercial tort claim and keep in mind that a pre-exiting security interest in proceeds may be superior to the interest in the commercial tort claim that you are obtaining.

OVER- SECURED CREDITOR IS ENTITLED TO ATTORNEYS’ FEES

(so, what’s special about that?)

An interesting case comes out of the Bankruptcy Court for the Northern District of Florida regarding attorney’s fees for secured lenders.  Although that case involved an individual chapter 11 debtor, its holding is helpful to those of us who practice in the commercial arena.  Section 506(b) of the Bankruptcy Code provides that:

An over secured creditor is entitled to interest and reasonable fees, costs or charges provided under the agreement or in accordance with state statute.

What this means to our readers is that so long as the collateral securing your loan is in excess of the amount owed to you, including interest, attorney’s fees, etc., and your agreement entitles you to attorney’s fees, then you may recover them from the debtor’s assets.

As we all know, from time to time debtors engage in conduct that require the secured lender and its counsel to expend considerable time and expense to protect the lender’s interest.  It is not uncommon to hear a debtor protest the fees charged to the estate by a secured creditor.  In a decision that came down April 21, 2016, in a case entitled In re:  Earl Bernard Britt, Sr., Debtor[1], debtor’s counsel objected to the secured creditors claim for legal fees because the lender’s legal fees exceeded those of the debtor’s.  The court held:

The debtor’s request for reduction of the Bank’s fees . . . merely because its fees exceed the debtor’s is not justified.  The debtor filed this chapter 11 voluntarily in order to take advantage of the benefits it might provide.  This forced the Bank to retain counsel to protect its interests.  . . .  The debtor cannot have it both ways:  He cannot invoke the provisions of the Bankruptcy Code and then complain when an over secured creditor accrues attorney’s fees as a result.

Notwithstanding, the Court did go on to review the attorney’s fees and found some items to be excessive and made reductions in accordance therewith.

The takeaway from this case is that an over secured creditor is entitled to its attorney’s fees even if those attorney’s fees exceed those of the debtor’s; and in all cases, a secured creditor’s attorney’s fees are subject to review of a reasonableness standard and thus, subject to reduction where a court feels that the fees have gone beyond what is reasonable.

[1] In re:  Earl Bernard Britt, Sr., Debtor 206WL3564222.

General Motors and the Second Circuit,…Again!

Last week, the Second Circuit Court of Appeals issued a significant decision regarding the General Motors bankruptcy.  You probably remember an earlier case, where the Second Circuit reversed the bankruptcy court’s determination that JPMorgan Chase and its syndicate could remain as a secured party despite having erroneously filed a UCC Termination Statement.  Last week’s decision is another blow to a significant bankruptcy court determination.  In its decision, the bankruptcy court found “new GM” to be clear from claims arising out of defective ignition switches, even though the claims were known or reasonably ascertainable by “old GM” prior to its sale of assets to “new GM,” and yet, “old GM” did not provide those plaintiffs and potential plaintiffs with notice of the bankruptcy sale.

The bankruptcy court ruled that the plaintiffs were not provided with notice as required by procedural due process, even though “old GM knew or with reasonable due diligence should have known of the[ir] . . . claims.”  Although publication notice was issued and parties are presumed to have received such notice, publication notice does not assure that claimants or potential claimants actually received notice.

Nonetheless, the bankruptcy court concluded that failure to give notice did not entitle plaintiffs to pursue their claims against new GM because even if they had received notice and objected, the bankruptcy court determined that it would have overruled the objection and approved the 363 Sale as it was.  The Second Circuit reversed that thinking.

The Second Circuit focused on the plaintiffs’ rights under the “due process clause” of the Fifth Amendment of the United States Constitution providing that:  “No person shall . . . be deprived of life, liberty, or property, without due process of law.”  This is one of the most fundamental rights afforded under our Constitution.

The Second Circuit maintained that the bankruptcy court erred by concluding that the lack of notice was inconsequential because any legal argument the plaintiffs would have brought would have failed, resulting in the approval of the 363 sale.  Taking in the entirety of the business circumstances and the lost opportunity to negotiate, the Second Circuit concluded that due process is not limited to the opportunity to make a legal argument. Rather, it is the opportunity to participate in the proceedings in a meaningful way.

Although the Federal Judge overseeing the product liability cases dismissed many of them by the end of last week, many remain, and there is the potential for “new GM” to become burdened with obligations it had not intended to assume as part of its “purchase.”

So what does this mean to us?  It certainly means that when we are funding a purchaser of assets in a 363 Sale we want to be assured that all creditors, potential creditors, and potential claimants have received fair notice so as to entitle them to due process.  That is a pretty tough standard because the lender only knows what it knows, and even in this situation, would not have known what GM knew – that there was a defective ignition switch that was causing accidents and deaths and that owners of GM vehicles would likely be asserting those claims.

This is a dilemma that lenders will need to focus on in financing acquisitions of assets under § 363.  Stay tuned, I suspect we will be discussing this in future blogs.

My ABF Journal article on UCC Requirements for use of generic and specific names

When I started my blog I assured our readers that I would continue to publish scheduled articles as I have over the years.   Of course, the purpose of the blog is to bring you up to date discussions on issues as they arise while often publication dates for articles are scheduled months in advance.  As it happens, a topic that was scheduled months in advance and is currently appearing in the ABF Journal, has picked up some steam – at least on a matter in which I am presently involved.   In my current matter, a security agreement provided a granting clause that granted to the secured party a security interest in “all assets.”   This conveniently has merged a current published article scheduled months in advance with a current issue (at least in my world).   Click here to see the article:  http://bit.ly/28x9AO9

 

Consigned Goods – Part II

A costly education.

The crisis in the oil and gas industry has provided considerable work for insolvency attorneys.  Several decisions in a case in the Western District of Washington State just came down and should be of interest to our readers.  One of these cases again addresses the perils that arise when a consignor fails to perfect its interest in goods delivered to a consignee.   In re: Pettit Oil Company began as a Chapter 11 but was subsequently converted to a Chapter 7 and the trustee brought an avoidance action against IPC (USA) Inc., a seller of fuel to Pettit Oil.

The pre-petition debtor and IPC had entered into a consignment agreement whereby IPC delivered fuel to the debtor’s terminals to be sold to its transportation customers.  The consigned fuel was not identified as such but the invoices for consigned fuel sold directed account debtors to make payments to an IPC lockbox.  To complicate matters, in addition to consigning fuel to the debtor it also sold fuel (as did other suppliers) that was not subject to the consigned agreement.   Invoices for non-consigned fuel directed account debtors to make their payments to a lockbox at Key Bank, the debtor’s secured lender.  Any customer might be purchasing both consigned and non-consigned fuel.  As a result customers often paid the Key Bank lockbox when it should have paid the IPC lockbox.  The consignment arrangement continued from the pre-petition period to the post petition period.

When Pettit commenced its Chapter 11 case it sought use of cash collateral.  Although the first interim order granting use of cash collateral did not address the IPC consigned fuel, subsequent interim orders did.  The second interim cash collateral order provided that any “amounts belonging to IPC” be sent to IPC not later than two banking days after deposit in the Key Bank cash collateral account, unless an objection was filed.  The third interim cash collateral order provided that the “amount of the Cash Collateral to be used by Debtor in its operations shall not include any amount in the Cash Collateral Account at KeyBank or in the Third Party Banks consisting of funds belonging to IPC.”  During this period the court also issued a First Supplier Order which authorized the debtor to purchase supplies from certain vendors.  IPC was included as a supplier.

During the three week period immediately following the petition date, there were six transfers from the Debtor’s KeyBank accounts to IPC whereby IPC received over $8 million from the debtor’s fuel sales. Three weeks into the Chapter 11 case, there was in excess of $1 million in inventory in the debtor’s fuel tanks that continued to generate accounts receivable. The accounts receivable generated from this inventory were either (1) paid by customers directly to the IPC Lockbox, (2) paid by customers to the KeyBank Lockbox and remitted to IPC, or (3) paid to the KeyBank Lockbox and retained by KeyBank.  The trustee brought an avoidance action against IPC to recover the post-petition transfers.

The court stated: “Pursuant to § 549, the Trustee may only avoid post-petition transfers of ‘property of the estate.’ IPC argues that the Trustee cannot avoid the post-petition transfers pursuant to § 549 because the sale proceeds of the petroleum products never became property of the estate.  Property of the estate is defined as ‘all legal or equitable interests of the debtor in property as of the commencement of the case.’ [Bankruptcy Code] Section 541(a)(1). The existence and nature of a debtor’s interest in property is determined by non-bankruptcy law.”

The court then focused on UCC §§ 9-102(20) (the definition of Consignment) and 9-319(a) and the impact of IPC’s failure to perfect.  It expressed concerns over IPC’s failure to perfect and whether IPC was a supplier or a consignor that neglected to perfect.  To the extent IPC was a supplier, it would be entitled to be paid for its post-petition sales of fuel.  The concern was how to treat the post-petition payments if IPC was a post-petition unsecured consignor.

“The Trustee does not disagree that title to the fuel inventory remained with IPC post-petition.  It is undisputed that the Consignment Agreement provides that title to inventory and proceeds remains with IPC.  As between the Debtor and IPC, therefore, IPC retained title to and ownership of the inventory and proceeds, even after the Debtor filed bankruptcy, and even though IPC failed to properly perfect its interest.  The Trustee, however, argues that title and ownership are irrelevant to the analysis of whether such inventory, and proceeds that flowed from such inventory, became property of the estate.”

The court did not determine IPC’s fate as an unperfected post-petition consignor and denied the motion for summary judgment:  “The answer may be that the analysis will be the same for property delivered as of the petition date or post-petition by virtue of § 541(a)(7), but neither party has provided sufficient analysis or authority for the Court to render a decision on this issue at this time. The issue in this case may be further complicated by the fact that the product was delivered post-petition pursuant to a prepetition agreement.”

Whether IPC ultimately prevails is inconsequential.  The cost of litigating the issue could have easily been avoided if it had been more knowledgeable concerning the consignments it intended.  As we indicated in our earlier blog, consignments remain a viable method to effect sales but consignors (and their lenders) must assure that the process for perfection is properly followed lest they be subject to a costly education.