During the first half of 2010, the United States Court of Appeals for the Ninth Circuit and the United States Court of Appeals for the Tenth Circuit issued decisions addressing the remedies available to a trustee following the avoidance as a Section 547FN1 preferential transfer of a non-possessory security interest. The decisions substantially overlap in their respective holdings, but the area of disagreement is practically significant, and the difference bodes ill for non-possessory secured creditors in the Ninth Circuit.
The Ninth Circuit In re Taylor and the Tenth Circuit In re Trout
The two cases are: USAA v. Thacker ( In re Taylor), 599 F.3d 880 (9th Cir.2010), decided on March 22, 2010, and Rodriguez v. Drive Financial Services, L.P. (In re Trout), — F.3d —-, 2010 WL 2510427 (10th Cir. 2010) decided on June 23, 2010. The Court of Appeals in Taylor described the facts in Trout as “indistinguishable” and provided the following description:
The debtors loaned auto buyers the purchase price of their cars through purchase-money security interests from the purchasers. The security interests were avoidable under § 547 and the trustee brought adversarial actions to avoid the transfers of the securities [sic] interests.
In re Taylor, 599 F.3d at 891 (citations omitted)
Both Courts of Appeal addressed the same legal issue: Upon avoidance of a non-possessory security interest, does the remedy afforded by Section 551 preclude the further award of monetary relief under Section 550(a)? In other words, can a trustee/debtor “have its cake” – acquire the avoided security interest for the debtor’s estate – and “eat it too” – get a monetary award equal to the value of the preferential security interest?
Both courts held that a bankruptcy court may, in its discretion, make a monetary award of the “value” of an avoided non-possessory security interest even after the trustee acquires the security interest through the automatic application of Section 551. The difference between the decisions – the Ninth Circuit opened the floodgates for trustees/debtors to pursue a 551/550(a) “double dip” while the Tenth Circuit was quite clear that only under very limited circumstances would such a dual remedy be appropriate.
A Brief Review of Section 551 and Section 550(a)
It is well established that the grant of or perfection of a security interest is considered a “transfer” of a debtor’s property. As a transfer, it is subject to avoidance if the requirements for avoidance in Section 547(b) are met and no defense is available. However, Section 547 leaves it to other Sections of Chapter 5 of the Bankruptcy Code to provide for the remedies available once a determination of avoidability is made.
The Court of Appeals in Trout provided a succinct summary of the two remedial sections under review:
Several bankruptcy code provisions work together to protect the bankruptcy estate from preferential transfers made within ninety days of filing the bankruptcy petition. First, under § 547, the trustee may avoid “any transfer of an interest of the debtor in property.” Once avoided, that transfer is automatically preserved for the estate under § 551, which provides: “Any transfer avoided under section … 547 … is preserved for the benefit of the estate but only with respect to property of the estate.” In the case of an avoided security interest or lien, as here, § 551 ensures that a trustee avoiding a senior lien moves into that priority position and the estate is not trumped by the interest of a junior lien. See Morris v. St. John Nat’l Bank ( In re Haberman), 516 F.3d 1207, 1210 (10th Cir.2008).
In addition to these remedies, 11 U.S.C. § 550(a) also provides:
[T]o the extent a transfer is avoided under section … 547 … the trustee may recover, for the benefit of the estate, the property transferred or, if the court so orders, the value of such property.
Ninth and Tenth Circuits Agree – Section 551 and Section 550(a) Remedies are Not Exclusive of each Other
Both the Ninth and Tenth circuits agreed that relief under Section tro550 and Section 551 are not mutually exclusive. Both Courts of Appeal held, in the case of non-possessory lien interests, lien avoidance and preservation under Section 551 might not put the estate back to its pre-transfer position. In these circumstances, the need to make the estate whole may make some monetary recovery under Section 550(a) appropriate.
The following holding taken from the Tenth Circuit’s holding in Trout is applicable to the Taylor decision as well:
While § 551 does prevent junior lienholders from leap-frogging the estate in the event a senior lien is avoided, this does not mean that § 551 does nothing remedial for the estate. [U]pon avoidance of a lien, under § 551 the trustee “steps into the shoes of the former lienholder, with the same rights in the collateralized property that the original lienholder enjoyed.” … Thus, as we discuss further below, in situations in which avoidance of the lien and its preservation for the estate are sufficient to make the estate whole, the trustee may not need to seek recovery under § 550, or, stated differently, relief under § 550 (to wit, return of the property) might be simply duplicative of what the trustee has already received through § 547 and § 551.
As to One, Limited Scenario the Courts Agree
Under one set of circumstances the Ninth and Tenth Circuit agree that mere lien preservation and avoidance under Section 551 would not make the debtor’s estate whole. This situation arises where the debtor’s pre-petition asset that was subject to the avoided lien has been sold (presumably pre-petition) to a good faith purchaser for value. The Tenth Circuit cited as an example the facts of Tidwell v. Chrysler Credit Corp. (In re Blackburn), “where a lien on the debtor’s pickup truck was avoided, but the dealer had, prior to the petition, repossessed the vehicle and sold it to a good faith purchaser.” 90 B.R. 569, 573 (Bankr.M.D.Ga.1987).
Beyond the intervening sale scenario, the Ninth and Tenth Circuits part ways in a dramatic fashion.
The Ninth and Tenth Circuit go to Different Corners of the Planet – When does Section 551 Preservation and Avoidance NOT Make the Debtor’s Estate Whole
In Taylor, the Ninth Circuit agreed with the bankruptcy court’s analysis that a Section 550(a) monetary remedy was appropriate after avoidance of a non-possessory lien “to correct for the difference between the value of the security interest at the time of the transfer (September 20, 2005) and the value of the security interest at the time of judgment (August 10, 2007).” The Ninth Circuit went on to agree that:
the value of a security interest is determined in part by the value of the secured asset, in this case the value of the Taylors’ car. Hence, the depreciation of the value of the car lowered the value of the security interest. Furthermore, the value of the security interest is determined in part by the outstanding balance of the Taylors’ debt. As the Taylors made payments to reduce their debt, the value of the security interest diminished.
Because hard assets almost by definition depreciate, under the Ninth Circuit’s analysis in Taylor, there are few imaginable circumstances where a preference claimant would not seek both avoidance and preservation of a non-possessory lien under Section 551 and monetary recovery under Section 550(a). Additionally, if payments made pursuant to a loan agreement reduce the value of the avoided security interest, then a preference claimant pursuing the holder of avoided non-possessory lien has the ability to recover the amount of payments as a reduction in the value of the security interest even when the payments themselves might have qualified for a defense – e.g. ordinary course of business defense.
In Trout, the Tenth Circuit rejected the notion that the loss in value of an asset through depreciation could form the basis for a monetary recovery against a non-possessory lien claimant. The logic of the Tenth Circuit is compelling:
Before the transfer of the security interest here, the estate had a depreciating asset and an obligation to an unsecured creditor. After the transfer, the estate still had the asset but a creditor had a secured priority interest in that asset. After avoidance of the lien, the estate once again had a depreciating asset and an unsecured obligation to the lender. Thus, as the BAP and the bankruptcy court concluded, on these facts, nothing more was required to put the estate back in its pre-transfer position.
The Tenth Circuit Court of Appeals in Trout, confronted with the Ninth Circuit’s decision in Taylor only 3 months earlier, sought to distinguish the Taylor decision:
We recognize that the time it takes to avoid the security interest could result in additional devaluation. In cases involving some inordinate delay, then there could conceivably be reason to award value to compensate for the decline that occurred in the interim. Though not entirely clear, this notion seems to be at play in the Ninth Circuit’s recent decision In re Taylor, in which nearly two years elapsed between the filing of the bankruptcy petition and the court finding the transfer avoidable (the trustee there waited seventeen months before seeking avoidance).
The Tenth Circuit’s acknowledged stretch to distinguish the Taylor case seems to be simply an effort of showing judicial respect to a peer court. In fact, the holdings in Taylor and in Trout squarely contradict each other in reasoning and holding on the question of whether depreciation can constitute the basis for a monetary award against the one time claimant of an avoided non-possessory lien.
Secured Party Behavioral Modification in the Ninth and Tenth Circuits
In the Ninth Circuit, creditors holding potentially avoidable liens going to have to face the reality that the liability on a preference claim may be increasing as the vehicle depreciates during the pendency of the bankruptcy and prior to the avoidance of the lien. This reality in the Ninth Circuit is going to put pressure of non-possessory lien claimants to engage in a more critical self assessment of potentially avoidable lien claims and consideration of abandonment of those lien claims. Also, the risk may provide further motivation for non-possessory lien claimants either to encourage the debtor to sell or to seek relief from the automatic stay to foreclose and sell the collateral. Presumably, even in the Ninth Circuit, the sale of a depreciating asset will cut off any further claim of monetary relief due to depreciation. Of course, a countervailing consideration is that a sale arguably establishes value of the depreciated asset, which is something that a bankruptcy preference claimant might otherwise find challenging to prove.
In the Tenth Circuit, the Trout decision should preclude any Section 550(a) award against avoided non-possessory lien claimants for depreciation. The only theoretical opening left by the Tenth Circuit might be if an effort by the debtor to sell or otherwise realize value from the asset during the pendency of the bankruptcy was impeded by the assertion of a subsequently avoided security interest. For this reason, non-possessory lien claimants in the Tenth Circuit might be more circumspect about opposing a debtor’s sale motion on any grounds other than preservation of the creditor’s lien claim in any proceeds from the sale.
In any event, in the Ninth Circuit, non-possessory lien claimants should be prepared to have their liens even more often and more thoroughly scrutinized, and those who have their liens avoided as preferential transfers under Section 547 should be prepared for a monetary award based on asset depreciation during the pendency of the bankruptcy.
For Bankruptcy Preference Claimants in Other Circuits – a “Red Bull” Boost in Motivation
And in the rest of the circuits, the Ninth Circuit’s decision will provide a “Red Bull” boost in the motivation of trustees and debtors to pursue Section 547 bankruptcy preference actions against holders of non-possessory security interests. These preference claimants are now looking at the possibility of a monetary award under Section 550(a), and not just avoidance and preservation of the avoided lien under Section 551. On top of that, bankruptcy preference claimants can add the possibility of recovery of the amount of the payments in the preference period without having to run the gauntlet of preference defenses as to the payments themselves. Indeed, the possible bankruptcy preference bounty on non-possessory lien holders just went way up.
FN1. Unless otherwise noted, all section references are to 11 U.S.C. and “Code” refers to the Bankruptcy Code.