In 2019, an investment advisor (the “husband”) entered into a loan agreement with his employer (the “creditor”), a wealth management company. The creditor took and perfected a security interest “in ‘all of [the husband’s] rights, title, and interest to all [his] assets…, whether now owned or hereinafter acquired, wherever located, and all proceeds…thereof.” However, the husband was later fired and, as a result, defaulted on the loan. After the creditor initiated arbitration to attempt to recover the unpaid amount (approximately $2.34 million), the husband’s wife (the “debtor”) filed for chapter 11 bankruptcy, which stayed the arbitration proceeding. In the meantime, the husband started employment with another financial firm, bringing a significant number of his old clients with him. At the time of filing, the husband and debtor had $1,230.61 in their bank account, and the husband was owed a little over $7,226.18 in advisory client fees from his new employer. As a result, the creditor had a secured lien on $8,456.79. However, the creditor also argued it was entitled to the husband’s post-petition client fees that were generated from advisory agreements the husband had entered into pre-petition because the fees were proceeds under 11 U.S.C. § 552(b). The bankruptcy court disagreed, finding that the total collateral was only $8,456.76, which the creditor collected.
In LPL Fin. LLC v. Bumstead (In re Bumstead), 782 F.Supp.3d 1026 (W.D. Wash. 2025), the court affirmed the bankruptcy court, finding that the creditor’s security interest did not extend to the post-petition client fees owed to the husband. The court first explained that under the bankruptcy code, “a bankruptcy filing cuts off security interests in property acquired by a debtor’s estate after ‘the commencement of the case’” 11 U.S.C. § 552(a). However, the creditor’s argument rested on § 552(b)(1), a narrow exception to § 522(a), which provides that “if a security agreement extends to property of the debtor acquired pre-bankruptcy and ‘to proceeds…of such property,’ then the security interest extends to those proceeds even if they are received” post-petition. The creditor argued that the client fees owed to the husband by the new employer were proceeds “because ‘they [were] derived from and [arose] out of’ [the creditor’s] pre-petition security interest in [the husband’s] accounts.” Further, the creditor emphasized that the security agreement covered investment advisory accounts held by the husband regardless of where the accounts were held, and that the fees owed to the husband were “directly and indisputably traceable to the original collateral.” First, the court found that the post-petition client fees were much more like post-petition accounts receivable attributable to the husband’s labor, in which the creditor did not have a security interest. The court looked to the Ninth Circuit Bankruptcy Appellate Panel’s (the “BAP”) holding that “revenue generated after filing for bankruptcy ‘solely as a result of a debtor’s labor is not subject to a creditor’s pre-petition interest.’” In re Skagit Pacific Corp., 316 B.R. 330 (9th Cir. BAP 2004). In other words, § 552(b) only permits a security interest to “encompass[ ] the cash collected on existing pre-petition accounts,” therefore, ‘[p]roceeds of post-petition accounts receivable do not fall within the § 552(b) proceeds exception.” Id. The court found that the client fees were the result of the husband’s labor and did not fall within the § 552(b) proceeds exemption. Next, the court found that even if the creditor had an interest in the fees because they were a result of its clients following the husband to the new employer, those fees were commingled with the husband’s post-petition earnings, and the creditor failed to prove using an approved tracing method that the fees corresponded to its original collateral. The Washington UCC, which conforms with §552(b), provides that a creditor’s security interest only continues post-petition in its collateral and “any identifiable proceeds.” RCW 62A.9A-315(a) (emphasis added). Both the Washington UCC and the BAP require that a creditor use proper methods of tracing permitted by law to trace back the proceeds to the pre-petition collateral. The court found that the debtor had failed to use any proper methods of tracing, and its testimony that the fees related to the pre-petition collateral were not enough.
By Conor Doris [email protected]
Edited By Taylor O’Brien [email protected]
Edited By Kristin Meurer [email protected]
Edited By Hayden Mariott [email protected]