Wednesday, May 1, 2019

Fifth Circuit Resolves Multi-State Perfection Puzzle

Stephen W. Sather
Barron & Newburger, P.C.
Austin, TX  
ssather@bn-lawyers.com

In a lesson that the Uniform Commercial Code is not always uniform between various states, the Fifth Circuit resolved a lien priority dispute pertaining to a Texas debtor who brought agricultural products in Oregon, Michigan and Tennessee.    The opinion in a valuable primer in choice of law issues in UCC cases as well as how failure to strictly comply with state statutes can lead to loss of lien priority.   Fishback Nursey, Incorporated v. PNC Bank, National Association, Case No. 18-10090 (5th Circuit 4/10/19).
What Happened
 BFN Operations, LLC was a wholesale grower of trees, shrubs, and other plants, with headquarters in Texas and offices in Michigan, Oregon and Tennessee.   
PNC held a blanket lien in the debtor's assets which pre-dated the claims of two vendors to the debtor, Fishback and Surface.
Fishback sold agricultural products to the debtor and filed UCCs in Oregon, Michigan and Tennessee.   It listed the debtor as BFN Operations, LLC abn Zelenka Farms.  It also filed a notice of lien in Oregon.
Surface filed a UCC in Michigan using the name "BFN Operations, LLC abn Zelenka Farms.
When BFN filed chapter 11, PNC extended debtor-in-possession financing which would outrank other liens "subject and junior only to . . . valid, enforceable, properly perfected, and unavoidable pre-petition liens."
Fishback and Surface filed suit against PNC in the U.S. District Court for the Northern District of Texas seeking a declaration that their liens were superior to those of PNC.
The District Court ruled that applicable choice of law rules dictated that the law of the states where the agricultural products were shipped should govern the lien perfection and priority dispute.  It then found that PNC had the prior lien because Fishback and Surface had failed to properly perfect.
The Court's Ruling
The first thing that the Fifth Circuit had to do was decide whether the District Court correctly determined that the law of the states where the agricultural products were shipped would apply.  The Court noted that choice of law could be applied based upon either the law of the forum state or under federal choice-of-law rules.   This is an open question in the Fifth Circuit.  The District Court found that it did not have to pick a side because both answers pointed to the states where the ag products were shipped.   The Fifth Circuit agreed.   Under the Texas UCC, if farm products are located in a jurisdiction, the local law of that jurisdiction applies to perfection, the effect of perfection and the priority of an agricultural lien on farm products.   Tex.Bus.&Com. Code Sec. 9.302.   Federal law relies on the Restatement (Second) of Conflicts of Law Sec. 251(2) which provides that absent "effective choice of law by the parties" the court should give "greater weight . . . to the location of the chattel at the time that the security interest attached."
Fishback argued that Oregon law should apply because its contracts contained a choice of law provision selecting Oregon law.  However, those provisions were included in a contract between the Debtor and Fishback.  As a result, they were not binding on PNC.
Each of the laws of the forum states had some quirky provisions.   In  Michigan and Tennessee, a UCC must be filed based on the debtor's name exactly as it appears on the public documents creating the entity.  In this case, the company's legal name was BFN Operations, LLC, not BFN Operations, LLC abn Zelenka Farms.   This may seem like a trivial distinction given that the name given was correct but added extra verbiage.   However, the Court found that it was "undisputed that, under the strict search logics in these states, searching with BFN’s correct name would not uncover the incorrectly named liens."    While this seems foolish, the states set out their search logic in regulations adopted to implement the UCC and that search logic would not catch the longer name.
Oregon was a different matter.  Agricultural liens in Oregon are automatically perfected until 45 days after the debt is due.  After that date, the party must file an extension supported by an affidavit.  Fishback did file an extension but it was not within the 45 day window so that PNC's lien jumped in front of its.  Fishback argued that its UCC filing met the requirement for the affidavit, but the Fifth Circuit found that it lacked the requisite information and would be misleading as an affidavit.
Takeaways
As bankruptcy lawyers, we are usually called in after the filings have been made and the lien perfection facts have been established.   Therefore, the biggest lesson for bankruptcy lawyers is that when dealing with multi-state perfection issues, there may be room to look for strategies to upset other parties' lien expectations.   
When dealing with the front end of a transaction, it makes good sense to consult with a local lawyer to find out the quirks in local lien law, whether it is the UCC or mechanics liens or real property mortgages.  One consequence of our federal system is that despite the efforts to draft uniform laws, states are perfectly free to implement traps for the unwary.

Mooting a Circuit Split


Hon. Judith K. Fitzgerald (Ret.)
JFitzgerald@tuckerlaw.com
Tucker Arensberg, P.C.
www.TuckerLaw.com

A case of interest to those who sell or purchase property in bankruptcy came down recently.  In Trinity 83 Development LLC v. ColFin Midwest Funding LLC, 2019 WL 987902 (7th Cir. March 1, 2019), the Court of Appeals for the Seventh Circuit overturned prior precedent by ruling that 11 U.S.C. § 363(m) does not moot appeals from sale orders.  A panel of the Court had previously decided In re Sax, 796 F.2d 994 (7th Cir. 1986), which stood for the proposition that any dispute that fell within the scope of § 363(m) was moot.  More recently in In re River West Plaza-Chicago, LLC, 664 F.3d 668 (7th Cir. 2011), § 363(m) was determined to prevent efforts to set aside the sale and, relying on Sax, to prohibit the court from putting the sale proceeds back into the estate.  Because Trinity 83 Development LLC was also a panel decision, its author, Judge Easterbrook, circulated the opinion to all active circuit judges but none asked for en banc review. 

Trinity 83 Development LLC involved a situation where, prepetition, a mortgagee erroneously satisfied a mortgage and when the mistake came to light, was corrected.  The Court of Appeals described the facts as follows:  In 2006 Trinity 83 Development borrowed about $2 million from a bank, giving in return a note and a mortgage on certain real property. In 2011 the bank sold the note and mortgage to ColFin Midwest Funding. ColFin relied on Midland Loan Services to collect the payments. In 2013 Midland recorded a document (captioned “satisfaction”) stating that the loan had been paid and the mortgage released. But the loan was still outstanding, and Trinity continued paying. In 2015 ColFin realized Midland's mistake and recorded a document cancelling the satisfaction. Soon afterward Trinity stopped paying, and ColFin filed a foreclosure action in state court.

Trinity 83 Dev., LLC v. ColFin Midwest Funding, LLC, No. 18-2117, 2019 WL 987902, at *1 (7th Cir. Mar. 1, 2019)

Trinity filed bankruptcy, which stopped the foreclosure.  After Trinity filed its bankruptcy, it sued ColFin, arguing that the release extinguished the debt and security interest.  The Bankruptcy Judge, later affirmed by the District Court, disagreed, and ruled that the release was a unilateral error that could be rectified unilaterally—and, as no one else had recorded a security interest between those two events, ColFin retained its original rights.  ColFin appealed but before the appeal was heard, the property was sold under the bankruptcy court's auspices.  ColFin contended that § 363(m) mooted the appeal.

The Seventh Circuit decided, inter alia, that the appeal was not constitutionally moot.  Section 363(m), deals with sales orders that have not been stayed and, as there is a live controversy regarding who should get the sales process, does not concern mootness at all.  Moreover, § 363(m) “does not say one word about the disposition of the proceeds of a sale or lease. The text is straight-forward: ‘The reversal or modification on appeal of an authorization ... of a sale or lease of property does not affect the validity of a sale or lease ... to an entity that purchased or leased such property in good faith’. What should be done with the proceeds is a subject within the control of the bankruptcy court.”   Trinity 83 Dev., LLC, supra, 2019 WL 987902, at *2.  Thus, the appellate court decided, a bankruptcy court is not prevented from deciding what to do with sales proceeds when its sale order has not been stayed.  This ruling brings the Seventh Circuit into line with other courts that have addressed this issue including, as noted by Judge Easterbrook, In re Hope 7 Monroe Street L.P., 743 F.3d 867, 872–73 (D.C. Cir. 2014); In re ICL Holding Co., 802 F.3d 547, 554 (3d Cir. 2015); and In re Brown, 851 F.3d 619, 623 (6th Cir. 2017).

Thursday, August 23, 2018

THE 11TH CIRCUIT CLARIFIES THAT NEW VALUE NEED NOT REMAIN UNPAID TO CONSTITUTE A VALID PREFERENCE DEFENSE


By: Jeffrey N. Schatzman
Schatzman & Schatzman, P.A.
Miami, Florida

            In Kaye v. Blue Bell Creameries, Inc. (In re BFW Liquidation, LLC), 2018 U.S. App. LEXIS 22504 * | __ F.3D __ | 2018 WL 3850101 (11th Cir 2018), decided on August 14, 2018, the Eleventh Circuit Court of Appeals made clear that any reliance on its decision in Charisma Investment Company, N.V. v. Airport Systems, Inc. (In re Jet Florida System, Inc.), 841 F.2d 1082 (11th Cir. 1988), that the new value exception (11 U.S.C. § 547(c)(4)) only applies if any new value given remains unpaid, is misplaced. In Jet Florida System, the Eleventh Circuit was faced with determining whether rent payments made by the debtor to a landlord after the debtor had vacated the premises were subject to the new value exception.  In considering the exception, the court stated that § 547(c)(4) “has generally been read to require: (1) that the creditor must have extended the new value after receiving the challenged payments, (2) that the new value must have been unsecured, and (3) that the new value must remain unpaid.”  In re Jet Fla. Sys., at 1083.  The court ultimately rendered its decision by applying only the first element and found that there was no new value given by the landlord since the debtor had vacated the premises and therefore, no benefit was conferred upon the estate.

Sunday, June 10, 2018

The Absolute Priority Rule (Probably) Still Applies in Individual Bankruptcy Cases

Stephen W. Sather
Barron & Newburger, P.C.
Austin, TX

The absolute priority rule under 11 U.S.C. §1129(b) is one of the fundamental principles of chapter 11.   Under the absolute priority rule, a debtor has three options:  (i)  obtain a favorable vote from all classes of unsecured creditors; (ii) pay unsecured creditors in full; or (iii) provide that interests junior to unsecured creditors will not receive or retain any property on account of their interest.
            In 2005, Congress amended the Bankruptcy Code to make Chapter 11 more like Chapter 13 for individual debtors.   Because of some inexact drafting a question arose as to whether the absolute priority rule continued to apply in individual cases.    While the majority view is that Congress did not abrogate the absolute priority rule in individual cases, there are still some circuits where the question remains open.
There are three relevant statutory sections.    First, section 1115 provides that property of the estate in an individual case included property acquired post-petition, including earnings from personal services.  Second, section 1129(a)(15) provides that in an individual case in which an unsecured creditor objected, the Debtor must submit his projected disposable income under the plan for a period of five years.
Finally, section 1129(b)(2)(B) provides that a plan would be fair and equitable with regard to a rejecting class of claims if:
(i) the plan provides that each holder of a claim of such class receive or retain on account of such claim property of a value, as of the effective date of the plan, equal to the allowed amount of such claim; or

(ii) the holder of any claim or interest that is junior to the claims of such class will not receive or retain under the plan on account of such junior claim or interest any property; except that in a case in which the debtor is an individual, the debtor may retain property included in the estate under section 1115, subject to the requirements of subsection (a)(14)* of this section. (emphasis added).

*--The reference to subsection (a)(14) should probably refer to subsection (a)(15) instead.

            The statutory provisions add certain post-petition property to the estate, require the Debtor to make payments of projected disposable income if a creditor objects and allow the Debtor to retain "property included in the estate under section 1115." This required an examination of just what property was included by section 1115. According to section 1115(a)
(a) In a case in which the debtor is an individual, property of the estate includes, in addition to the property specified in section 541—
(1) all property of the kind specified in section 541 that the debtor acquires after the commencement of the case . . . ; and
(2) earnings from services performed by the debtor after the commencement of the case. . . . .

Courts which have examined this language have divided between a "narrow" interpretation holds that "property included in the estate under section 1115" refers only to the post-petition property added to the estate, while the "broad" interpretation holds that section 1115's reference to "property specified in section 541" refers to all section 541 property. Under the broad interpretation, because section 1115 encompassed all section 541 property, the Debtor could retain all of his property without violating the absolute priority rule.   For a brief period of time, the broad approach seemed to be gaining favor.   However, today all circuit courts which have addressed the issue and most lower courts have followed the narrow approach in which the absolute priority rule continues to apply.
The trend in the cases is definitely in favor of the narrow approach.   The Fourth, Fifth, Sixth, Ninth and Tenth Circuits have all adopted this approach, while no circuit court has followed the broad approach.   While there is still a split of authority in the First, Seventh, Eighth and Eleventh Circuits, they are likely to come around to the narrow approach.
 


Circuit
Narrow Approach
Broad Approach
Status
First
In re Walsh, 447 B.R. 45 (Bankr. D. Mass. 2011); In re Lee Min Ho Chen, 482 B.R. 473 (Bankr. D. P.R. 2012)
In re Perez, 2015 Bankr. LEXIS 1488 (Bankr. D. P.R. 2015)
Courts split.  No consensus.
Second
In re Lucarelli, 517 B.R. 42 (Bankr. D. Ct. 2014);

Only case found follows narrow approach
Third
Brown v. Ferroni (In re Brown), 505 B.R. 638 (E.D. Pa. 2014); In re Grasso, 497 B.R. 448 (Bankr. E.D. Pa. 2013)

Only cases found follow narrow approach
Fourth
In re Maharaj, 681 F.3d 558 (4th Cir. 2012)

Definitely Narrow Approach
Fifth
In re Lively, 717 F.3d 406 (5th Cir. 2013)

Definitely Narrow Approach
Sixth
Ice House America, LLC v. Cardin (In re Cardin), 751 F.3d 734 (6th Cir. 2014)

Definitely Narrow Approach
Seventh
In re Gerard, 495 B.R. 850 (Bankr. E.D. Wisc. 2013); In re Draiman, 450 B.R. 777 (Bankr. N.D. Ill. 2011)
In re Johnson, 402 B.R. 851 (Bankr. N.D. Ind. 2009)
Courts split.  No consensus.
Eighth
Heritage Bank v. Woodward (In re Woodward), 537 B.R. 894 (8th Cir. BAP 2015)
In re Tegeder, 369 B.R. 477 (Bankr. D. Neb. 2007); In re O’Neal, 490 B.R. 837 (Bankr. W.D. Ark. 2013); In re Woodward, 2014 Bankr. LEXIS 1940 (Bankr. D. Neb. 2014)
Courts split.  No consensus.
Ninth
Zachary v. Cal. Bank & Trust, 811 F.3d 1191 (9th Cir. 2016)

Definitely Narrow Approach
Tenth
Dill Oil Company v. Stephens (In re Stephens), 704 F.3d 1279 (10th Cir. 2013)

Definitely Narrow Approach
Eleventh
In re Martin, 497 B.R. 349 (Bankr. M.D. Fl. 2013); In re Gelin, 437 B.R. 435 (Bankr. N.D. Fl. 2010); In re Steedley, 2010 Bankr. LEXIS 3113 (Bankr. S.D. Ga. 2010); In re Gbadebo, 431 B.R. 222 (Bankr. N.D. Cal. 2010); In re Rogers, 2016 Bankr. LEXIS 2398 (Bankr. S.D. Ga. 2016)
SPCP Group, LLC v. Biggins, 465 B.R. 316 (M.D. Fl. 2011)
Cases lean toward narrow approach