In re Messamore, Bankruptcy No. 99-41688. Adversary No. 99-4113.
| Decision Date | 21 July 2000 |
| Docket Number | Bankruptcy No. 99-41688. Adversary No. 99-4113. |
| Parties | In re Donald & Dena MESSAMORE, Debtors. Michelle L. Vieira, Chapter 7 Trustee, Plaintiff, v. Anna National Bank, Defendant. |
| Court | United States Bankruptcy Courts. Seventh Circuit. U.S. Bankruptcy Court — Southern District of Illinois |
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Michelle L. Vieira, Carbondale, IL, for plaintiff.
Gary E. Stark, Cairo, IL, for defendant.
The trustee in this case seeks to avoid, as a preference, the lien of Anna National Bank ("Anna Bank") on the debtors' mobile home. Anna Bank's lien, taken to refinance the debtors' obligation to another creditor, Green Point Credit ("Green Point"), was not perfected for more than two months following the parties' transaction because of a delay in obtaining the mobile home title showing a release of Green Point's lien. The trustee contends that, as a result, the debtors' obligation to Anna Bank was rendered an antecedent debt, and Anna Bank's perfection of its lien within 90 days of bankruptcy constituted a transfer of the debtors' interest in property "on account of" this antecedent debt, which is voidable under 11 U.S.C. § 547(b).1 Anna Bank responds that, due to the circumstances surrounding the transaction, perfection of its lien did not constitute a transfer of the debtors' property on account of an antecedent debt and, thus, perfection of its lien should be excepted from avoidance under § 547.
The facts are undisputed. On June 24, 1999, the debtors, Donald and Dena Messamore, entered into a loan transaction with Anna Bank to refinance a debt to Green Point secured by their mobile home. Green Point had originally financed the debtors' purchase of the mobile home in April 1996 and held a lien on its title. By letter dated June 29, 1999, Anna Bank mailed the payoff amount to Green Point and requested Green Point to forward the mobile home title directly to Anna Bank. See Def.'s Brief, filed March 21, 2000, Ex. A. On July 6, 1999, Green Point released its lien on the mobile home title. However, instead of mailing the title to Anna Bank, Green Point forwarded it to the debtors.
Anna Bank subsequently obtained the title from the debtors and, on August 25, 1999, mailed it to the Illinois Secretary of State along with an application requesting a corrected title showing Anna Bank as lienholder. The Secretary of State received the application and title on August 30, 1999.2 On September 13, 1999, the debtors filed a petition for relief under Chapter 7 of the Bankruptcy Code.
The trustee brought this preference action, alleging that because Anna Bank failed to perfect its lien on the debtors' mobile home within the time period specified for precluding avoidance as a preference, such perfection resulted in a transfer on account of an antecedent debt that must be avoided.3 In its answer, Anna Bank admitted that perfection of its lien constituted a transfer of the debtors' interest in property but denied that such transfer was on account of an antecedent debt. Anna Bank additionally raised several affirmative defenses, including that the transfer was intended to be and was, in fact, a substantially contemporaneous exchange for new value given to the debtors.4
At hearing on the trustee's complaint, Anna Bank advanced a further argument that under the "earmarking doctrine" as applied in In re Heitkamp, 137 F.3d 1087 (8th Cir.1998), and In re Ward, 230 B.R. 115 (8th Cir. BAP 1999), no avoidable preference occurred in this case because, by virtue of the debtors' agreement to refinance their obligation to Green Point with the proceeds of Anna Bank's loan, Anna Bank's interest in the mobile home was merely substituted for that of Green Point. Consequently, the bank contends, there was no transfer of the debtors' interest in property and no diminution of the debtors' estate. Anna Bank asserts that, by reason of the earmarking doctrine, the trustee has failed to establish one of the requisite elements for avoidance under § 547(b) — "transfer of an interest of the debtor in property" — and, thus, the trustee's complaint to avoid the bank's lien as a preference must fail.5
The earmarking doctrine invoked by Anna Bank is a judicially created exception to § 547(b) deriving from the requirement that a transfer, in order to be preferential, must be "of an interest of the debtor in property."6 Essentially, a transfer is preferential only if it diminishes the fund to which other creditors can look for payment of their debts, thus making it impossible for similarly situated creditors to obtain as great a percentage as the favored creditor. See 5 Collier on Bankruptcy, ¶ 547.03.2, at 547-20 to 547-21, 547-23 to 547-24 (15th ed. rev.2000). If a third party, such as a surety or guarantor, makes a payment to a creditor of the debtor, there is no transfer of the debtor's property and, since the debtor's funds are not diminished, this transfer is not a preference. Id. at 547-21.
Similarly, when a debtor borrows money from a third party to pay a specific creditor, transfer of the borrowed funds does not constitute a preference if the loan is conditioned on payment of the designated creditor and the creditor is, in fact, paid. See In re Smith, 966 F.2d 1527, 1533 (7th Cir.1992). In such an instance, the funds are said to be "earmarked" for the creditor in question and never become property of the debtor. Id. The transfer is not preferential because the debtor never exercises control over the new funds, and the debtor's property — the fund out of which existing creditors can be paid — is not diminished. Id.
The earmarking doctrine, as developed in case law, is clearly applicable in a refinancing situation to determine whether the debtor's payment of an existing creditor with funds borrowed from a new creditor constitutes a preferential transfer — that is, whether such payment is a transfer of the debtor's "interest in property" to pay the debt owed to the first creditor. This case, however, presents an entirely different question. Here, it is not the transfer of funds to the debtors' original creditor, Green Point, that is at issue,7 but the transfer that occurred when the new creditor, Anna Bank, perfected its lien on the debtors' mobile home more than 10 days after execution of the parties' loan agreement. Under the definition of "transfer" applicable in preference actions,8 the debtors' transfer of an interest in their mobile home did not occur at the time of the loan transaction when they incurred their obligation to Anna Bank. Rather, because Anna Bank failed to perfect within 10 days after the parties' transaction, transfer of the debtors' interest is deemed to have occurred at the time Anna Bank perfected its lien over two months later. See 11 U.S.C. § 547(e)(2)(B). It is this latter transfer, the transfer of the debtors' interest in the mobile home to Anna Bank to secure their pre-existent obligation, that the trustee alleges is preferential.
Although the debtors' transfer to Anna Bank arose in the context of a refinancing arrangement, it did not involve the payment of funds by a third party or, indeed, the payment of borrowed funds at all. For this reason, the earmarking doctrine has no logical relevance to such transfer. The transfer to Anna Bank that occurred upon perfection of its lien was separate and distinct from the transfer that occurred when Green Point was paid with borrowed funds, and this transfer was clearly a transfer of the debtors' interest in property, as it depended on the debtors' grant of a security interest to Anna Bank. The earmarking doctrine, therefore, is inapplicable in the present case to shield the debtors' transfer to Anna Bank from avoidance as a preference.
In so ruling, the Court declines to follow the reasoning of the Heitkamp and Ward cases, cited by Anna Bank in support of its position. Like the present case, Heitkamp and Ward each involved a preference action against a new creditor who supplied funds to pay a previous creditor but who neglected to timely perfect its security interest in the debtor's property. The court in each case found the earmarking doctrine applicable as a defense for the new creditor. However, the court's analysis failed to distinguish between the transfer of borrowed funds to the original creditor and the subsequent transfer that occurred when the new creditor belatedly perfected its security interest in the debtor's property. The earmarking doctrine, while appropriate to prevent avoidance of the transfer of borrowed funds to the original creditor, was wrongly invoked as a defense for the new creditor's tardy perfection.
In Heitkamp, the debtors, who owed several subcontractors for goods and services supplied in constructing a house, obtained a loan from the defendant bank, and the bank took a second mortgage on the house. See 137 F.3d at 1088. The bank issued cashier's checks payable to specific subcontractors and required the debtors to obtain mechanics' lien waivers from the subcontractors in exchange for the checks. However, due to an oversight, the bank did not record its mortgage until four months later, shortly before the debtors' bankruptcy filing. See id. The trustee sued to set aside the debtors' transfer of the second mortgage interest to the bank as a preference.
The Eighth Circuit Court of Appeals, although purportedly following established earmarking doctrine, see 137 F.3d at 1088, ruled that the doctrine applied in that case to preclude avoidance of the bank's second mortgage. The court made no mention of the bank's failure to timely perfect its mortgage but found, rather, that the debtors' estate was not diminished because the bank essentially "took over the subcontractors' security interest in the house." 137 F.3d at 1089. The court further determined that the transfer of the mortgage interest to the bank "merely replaced the subcontractors' security interest" and concluded, therefore, that there was no transfer of the...
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