FirsTrust Bank v. Indus. Bank (In re Essex Constr., LLC), Case No. 16-24661-TJC

• Decision Date: 25 September 2018
• Docket Number: Adversary No. 17-00156,Case No. 16-24661-TJC
• Citation: 591 B.R. 630
• Parties: IN RE: ESSEX CONSTRUCTION, LLC, Debtor Firstrust Bank, Plaintiff v. Industrial Bank, Defendant
• Court: U.S. Bankruptcy Court — District of Maryland

591 B.R. 630

IN RE: ESSEX CONSTRUCTION, LLC, Debtor

Firstrust Bank, Plaintiff

v.Industrial Bank, Defendant

Case No. 16-24661-TJC

Adversary No. 17-00156

United States Bankruptcy Court, D. Maryland, at Greenbelt.

Signed September 25, 2018

Jennifer Larkin Kneeland, Watt, Tieder, Hoffar & Fitzgerald, LLP, McLean, VA, for Plaintiff.

Catherine Keller Hopkin, Yumkas, Vidmar, Sweeney & Mulrenin, LLC, Columbia, MD, for Defendant.

MEMORANDUM OF DECISION

THOMAS J. CATLIOTA, U.S. BANKRUPTCY JUDGE

Before the court are cross-motions for summary judgment filed by defendant Industrial Bank and plaintiff Firstrust Bank. ECF 7, 11. As of the petition date, both banks held perfected security interests in all of the assets of debtor Essex Construction, LLC, with Industrial Bank's security interest being senior to that of Firstrust. Industrial Bank's financing statement lapsed post-petition on February 13, 2017, when it failed to file timely a continuation statement. Firstrust argues that, as a result of the lapse, Industrial Bank's lien ceased to be perfected and now Firstrust, rather than Industrial Bank, holds the first priority position in the debtor's assets. Industrial Bank disagrees, and argues that in bankruptcy, liens are fixed as of the petition date, and therefore the post-petition lapse in its financing statement does not alter its senior position.

For the reasons below, the court concludes that the post-petition lapse of Industrial Bank's financing statement did not result in Firstrust becoming the senior security interest holder. The court therefore will grant Industrial Bank's motion for summary judgment and deny Firstrust's motion.

The court has jurisdiction over this matter under 28 U.S.C. §§ 1334 and 157(b) and Local Rule 402 of the United States District Court for the District of Maryland. This court has authority to enter a final judgment under 28 U.S.C. § 157(b)(2)(K) and (O) and consistent with the standards of Stern v. Marshall , 564 U.S. 462, 131 S.Ct. 2594, 180 L.Ed.2d 475 (2011).

Statement of Undisputed Material Facts

On November 4, 2016, the debtor filed a voluntary petition under Chapter 11 of the Bankruptcy Code. On December 5, 2016, the United States Trustee filed a motion to appoint a Chapter 11 trustee, or to convert the case to Chapter 7. ECF 70 (16-24661). Ultimately, the debtor consented to the appointment of a trustee and the court confirmed the appointment of Bradford Englander as the Chapter 11 trustee on March 21, 2017. ECF 288 (16-24661).

Both Industrial Bank and Firstrust made prepetition loans to the debtor secured by all of the debtor's assets. Industrial Bank loaned the debtor $250,000, evidenced by a promissory note and a loan and security agreement dated February 3, 2012. Industrial Bank asserts that the outstanding balance was $289,985.83 as of the petition date. See Claim No. 6 (16-24661).

Industrial Bank recorded its UCC-1 financing statement on February 13, 2012, covering "all of the debtor's assets." ECF 7-1. There is no dispute that the security agreement grants Industrial Bank a lien on all of the debtor's assets and the security interest was perfected as of the petition date. Industrial Bank recorded a UCC-3 continuation statement on February 22, 2017, more than five years after it recorded the original UCC-1 financing statement. ECF 7-2.

Firstrust made several loans to the debtor. The first loan was made on April 22, 2014, for $1,260,000, evidenced by a promissory note and loan agreement. ECF 1-1. The second Firstrust loan was made on April 22, 2014, for $3,240,000, also evidenced by a promissory note and loan agreement. ECF 1-2. Firstrust asserts a total claim, as of the petition date, of $5,174,104. See Claim No. 13 (16-24661).

Firstrust recorded its UCC-1 financing statements on May 8, 2014. The UCC-1 financing statements cover "all of the debtor's personal property." ECF 1-15. There is no dispute that the security agreement grants Firstrust a lien on all of the debtor's assets and the security interest was perfected as of the petition date.

The Chapter 11 trustee is undertaking an orderly liquidation of the debtor's assets. He reports that the proceeds from the liquidation will not be sufficient to pay the liens of the banks in full. Accordingly, the relative priority between the banks' liens will have significant consequences to the banks' recoveries.

Conclusions of Law

The motion is governed by Federal Rule of Civil Procedure 56, made applicable here by Federal Rule of Bankruptcy Procedure 7056. A court may award summary judgment only when there is no genuine issue as to any material fact and the moving party is entitled to judgment as a matter of law. Here, the parties agree that the material facts are not in dispute and the cross-motions raise purely legal issues, and therefore summary judgment is appropriate.

Other than exceptions not pertinent here, under the Uniform Commercial Code adopted in Maryland, "a filed financing statement is effective for a period of five years after the date of filing." Md. Code Ann., Com. Law § 9-515(a) (LexisNexis 2018).

The effectiveness of a filed financing statement lapses on the expiration of the period of its effectiveness unless before the lapse a continuation statement is filed pursuant to subsection (d). Upon lapse, a financing statement ceases to be effective and any security interest or agricultural lien that was perfected becomes unperfected unless the security interest is perfected otherwise. If the security interest or agricultural lien becomes unperfected upon lapse, it is deemed never to have been perfected as against a purchaser of the collateral for value.

Com. Law § 9-515(c).¹ A bank that extends credit and obtains a voluntary security interest is a "purchaser of the collateral for value" within the meaning of § 9-515(c). § 1-201(29).²

A "continuation statement may be filed only within six months before the expiration of the five-year period ...." § 9-515(d). The consequence of a lapse in a financing statement of a senior perfected security interest in relation to a junior perfected security interest is explained in the Comments to the UCC:

3. Lapse. When the period of effectiveness under subsection (a) or (b) expires, the effectiveness of the financing statement lapses. The last sentence of subsection (c) addresses the effect of lapse. The deemed retroactive unperfection applies only with respect to purchasers for value; unlike former Section 9-403(2), it does not apply with respect to lien creditors.

Example 1: SP-1 and SP-2 both hold security interests in the same collateral. Both security interests are perfected by filing. SP-1 filed first and has priority under § 9-322(a)(1). The effectiveness of SP-1's filing lapses. As long as SP-2's security interest remains perfected thereafter, SP-2 is entitled to priority over SP-1's security interest, which is deemed never to have been perfected as against a purchaser for value (SP-2). See § 9-322(a)(2).

§ 9-515 cmt. 3. The result differs if the junior interest holder is a "lien creditor," a term that includes a bankruptcy trustee:³

Example 2: SP holds a security interest perfected by filing. On July 1, LC acquires a judicial lien on the collateral. Two weeks later, the effectiveness of the financing statement lapses. Although the security interest becomes unperfected upon lapse, it was perfected when LC acquired its lien. Accordingly, notwithstanding the lapse, the perfected security interest has priority over the rights of LC, who is not a purchaser. See § 9-317(a)(2).

Id.

The parties agree on the effect of much of the foregoing provisions of the UCC. There is no dispute that, as of the petition date, each bank held a perfected security interest in all assets of the debtor, and that Industrial Bank's security interest was senior to that of Firstrust. Industrial Bank concedes that it did not file a continuation statement on or before February 13, 2017, the fifth anniversary of recording its original UCC-1 financing statement. The parties also agree that, outside of bankruptcy, the failure of Industrial Bank to file timely a continuation statement would cause a lapse in the effectiveness of its financing statement, and would result in Firstrust taking the senior secured position. This is because the parties agree that Firstrust is a "purchaser of the collateral for value" within the meaning of § 9-515(c). Further, the parties agree that, outside of bankruptcy, although Industrial Bank's security interest would become junior to Firstrust's position, it would not lose its security interest entirely as a result of the lapse. This is the result under § 9-515(c), which provides that the effectiveness of the financing statement lapses, but the underlying security interest is not lost. No other creditor claims a lien in the debtor's assets arising either before or after the lapse.

The dispute is whether the foregoing application of the UCC should be different because the debtor was the subject of a Chapter 11 proceeding when the lapse occurred. It is well established that "[p]roperty interests are created and defined by state law. Unless some federal interest requires a different result, there is no reason why such interests should be analyzed differently simply because an interested party is involved in a bankruptcy proceeding." Butner v. United States, 440 U.S. 48, 55, 99 S.Ct. 914, 59 L.Ed.2d 136 (1979). See also , Am. Bankers Ins. Co. of Florida v. Maness , 101 F.3d 358, 363 (4th Cir. 1996) ("while federal law creates the bankruptcy estate, Butner and the cases following it establish that state law, absent a countervailing federal interest, determines whether a given property falls within this federal framework."). This principle applies to security interests: "The justifications for application of state law are not limited to ownership interests; they apply with equal force to security interests, including the interest of a mortgage in rents earned by mortgaged property." Butner, 440 U.S. at 55...