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.