The creditors advanced money under a written agreement to the debtor in exchange for the debtor's promise to sell to the creditors a specified dollar amount of unspecified receivables. The agreement further specified that to secure the debtor’s performance, the debtor would grant the creditor as collateral a security interest in “all accounts, including without limitation, all deposit accounts, accounts-receivable, and other receivables, chattel paper, documents and instruments” as defined by Article 9 of the UCC, “now or hereafter owned or acquired by” the debtor. Thereafter, the debtor filed for Chapter 11 bankruptcy. The debtor objected to the creditor’s assertion that it had a secured status in the collateral. However, the creditor responded arguing that (1) the “[d]ebtor failed to rebut the prima facie validity of [its] [c]laim;” (2) the value of the collateral had been improperly determined and “forward-looking valuation” was the proper valuation method rather than valuing the collateral on the petition date; (3) the creditor held an interest in the debtor’s post-petition accounts receivables and was not limited to an interest in pre-petition accounts receivable by 11 U.S.C. § 552(a); and (4) under the pre-petition agreement, it “owned” the debtor’s post-petition account receivables. Note that 11 U.S.C. § 552(a) provides “[e]xcept as provided in subsection (b) of this section, property acquired by the estate or by the debtor after the commencement of the case is not subject to any lien resulting from any security agreement entered into by the debtor before the commencement of the case.” During the bankruptcy case, the court determined that the debtor's pre-petition cash and receivables were fully encumbered by a first-perfected security interest held by a bank. The bankruptcy court’s order disallowed the creditor’s claim as a secured claim but allowed it as a general unsecured claim.
In In re Watchmen Sec. LLC, No. 24-00087-JMC-11, 2024 WL 4903363, 2024 Bankr. LEXIS 2871 (Bankr. S.D. Ind. Nov. 20, 2024) (opinion not yet released for publication), the court sustained the debtor’s objection and disallowed the claim as a secured claim and allowed the claim as a general unsecured claim. The court addressed three issues in its opinion: (1) the creditor’s interest in pre-petition receivables; (2) the creditor’s interest in post-petition receivables; and (3) whether a loan or true sale gave rise to the creditor’s interest. In determining the creditor’s interest in the debtor’s pre-petition accounts receivable, the court found it was inferior to the security interest held by the bank. The small value of receivables as of the petition date in relation to the significant amount of prior secured debt owed to the bank left “no value in the prepetition receivables to create any allowable secured claim for the [c]reditor” under 11 U.S.C. § 506(a). The court then found that the creditor had no interest in post-petition receivables. The creditor asserted it acquired, by pre-petition agreement, the debtor’s post-petition accounts receivable. The court held that the written agreement could not affect a pre-petition sale of post-petition receivables, and the debtor “could not effect a post-petition transfer of any interest in post-petition receivables by sale or grant of a security interest.” The court emphasized that a pre-petition debtor would not have “the authority [or] power to sell or otherwise transfer any interest in accounts which do not come into existence until post-petition.” The court went further to note that even if somehow the creditor had an interest in post-petition receivables, there was nothing provided by the creditor indicating how that interest would not also be inferior to any interest the bank had. Finally, the court determined that the creditor also did not “own” any of the debtor’s receivables because the pre-petition agreement did not constitute a true sale, but was, in fact, a secured loan; therefore, the creditor’s interest was a security interest, not outright ownership, as the creditor had claimed. In determining whether there is a true sale or merely a security interest to secure repayment of a loan, courts consider: “(1) whether the buyer has a right of recourse against the seller; (2) whether the seller continues to service the accounts and commingles receipts with its operating funds; (3) whether there was an independent investigation by the buyer of the account debtor; (4) whether the seller has a right to excess collections; (5) whether the seller retains an option to repurchase accounts; (6) whether the buyer can unilaterally alter the pricing terms; (7) whether the seller has the absolute power to alter or compromise the terms of the underlying asset; and (8) the language of the agreement and the conduct of the parties.” The court found that the pre-petition agreement between the parties reflected at least seven of the above factors and indicated that the agreement was for a security interest to repay a loan, rather than a true sale. Furthermore, the creditor bore no risk, while the debtor bore the entirety of the risk of non-payment, further indicative of the existence of a loan. Therefore, the court concluded that, because the creditor was only granted a security interest under the pre-petition agreement, any claims for post-petition receivables with a security interest would be defeated under Bankruptcy Code Section 552(a).
By Jace Brown [email protected]
Edited By Olivia Lewis [email protected]
Edited By Kristin Meurer [email protected]
Edited By Hayden Mariott [email protected]