The debtor was a business that factored receivables before it went bankrupt. Upon bankruptcy, the court appointed a trustee who later obtained some funds resulting from a settlement between the trustee and the debtors president. The creditor, in this case, was an individual who had purchased a promissory note from the debtor in exchange for an agreement that granted the creditor a security interest on essentially all the debtor’s assets (“Security Agreement”). The creditor argued that because he had a superior perfected security interest in the debtor’s assets, he was entitled to the funds the trustee had received in the settlement. However, according to Pennsylvania law, (which reflects Article 9 of the UCC to the extent relevant here) the creditor’s security interest was only recoverable from the settlement amount if that action sounded in a contractual obligation of the debtor to pay the funds rather than having arisen from a tort.
In In re Main Street Business Funding, LLC, Case No. 19-10598 (BLS), 2024 WL 1296907, 2024 Bankr. LEXIS 732 (Bankr. De. Mar. 26, 2024) (opinion not yet released for publication), the court found that the creditor’s security interest was superior to the trustee’s position. For that reason, the creditor should have been paid from the settlement amount because the claims brought in relation to the settlement were contractual instead of tortious. First, the court examined the “Gist of the Action” doctrine, which precludes recovery from parties that may seek to frame a contractual breach as a tortious violation in an attempt to recover additional damages. Accordingly, the court needed to look at the causes of action found in the earlier litigation and determine if the settlement that arose thereof was predominantly from a contractual claim or a tortious one. The trustee had brought seven causes of action, of which the court found four to be contractual and three to be tortious. However, the court reasoned that the heart of the litigation was a contractual obligation to repay, and everything else simply arose therefrom. Therefore, the court determined the settlement had been a settlement of a contractual action. Next, the court had to determine whether the creditor’s security interest reached the settlement proceeds. The court noted that the security agreement granted the creditor a security interest in accounts and in general intangibles, and therefore the creditor’s security interest was in fact, superior, and the security agreement made it possible for the creditor to recover everything he was owed out of the settlement proceeds.
By Maycee Redfearn, [email protected]
Edited By Ashley Boyce, [email protected]
Edited By Hayden Mariott, [email protected]