Workshop on Bankruptcy

May 17–19, 2001
St. Louis, Missouri

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Lois R. Lupica, Associate Professor of Law
University of Maine School of Law

© 2001 Lois R. Lupica

1. Theme running through Revised Article 9: The enhancement of secured creditors’ rights. Net effect: To the extent that the Bankruptcy Code looks to non-bankruptcy law (Revised Article 9) to determine the property rights of creditors, secured creditors will be able to encumber a greater number of types of assets more easily - leaving fewer assets remaining for residual claimants.
2. Article 9 scope has expanded:
   1. It is now easier for creditors to take a security interest in a greater number of types of assets.
      1. Commercial tort claims (See Revised § 9-102(a)(3) (definition); § 9-109(d)(12) (non-commercial tort claims are not included within the scope of Revised Article 9).
      2. Deposit accounts (as original collateral in non-consumer transactions) (See Revised § 9-102(a)(29) (definition); § 9-104 (description of how to “control” a deposit account);
      3. Health-care-insurance receivables (See Revised § 9-102(a)(2) & § 9-102(a)(46) (included within collateral category “account”).
      4. But. . . under some states’ non-uniform version of current Article 9, creditors can take a security interest in deposit accounts as original collateral (See e.g., Cal. U. Com. Code § § 4210 & 9104).
      5. Common law or non-article 9 statutory law may provide a method of attachment and perfection of security interest or the equivalent in some of these types of assets.
   2. Easier to securitize a greater number of types of assets.
      1. Expanded definition of account (See § 9-102(a)(2)).
      2. Therefore expanded number of types of assets that can be sold, subject to the terms of Article 9.
      3. Article 9 sales coverage expanded to include payment intangibles and promissory notes (See Revised § 9-109(a)(3) (. . . this article applies to . . . a sale of accounts, chattel paper, payment intangibles or promissory notes));
      4. Enhanced assignability of accounts, general intangibles and promissory notes (See Revised § 9-406 & 9-408 (limiting certain restrictions on asset transfers)).
   3. Expanded definition of “proceeds” (See Revised § 9-102(a)(64)(“whatever is acquired upon the sale, lease, license, exchange, or other disposition of collateral,” and “rights arising out of collateral.”)).
      1. This definition eliminates the requirement that collateral must be “disposed of” to constitute proceeds. For example, payment streams from the licensing of intellectual property falls within the definition of proceeds, whether or not any portion of the underlying intellectual property was “disposed of” under the license.
      2. Section 552 of the Bankruptcy Code makes a distinction between proceeds and after acquired property. Security interests in post-petition assets are not recognized in bankruptcy, but security interests in proceeds of pre-petition assets are. See 11 U.S.C. § 552(a) & (b)).
      3. Because what was after acquired property is now proceeds, there will be greater number of encumbered assets in debtors’ bankruptcy estates, and a correspondingly smaller number of assets available for debtors’ residual claimants.
3. It is now easier to take a security interest and have that security interest capture a greater number of debtor’s assets
   1. The procedures for perfection have been simplified and streamlined:
      1. There is now a single place to file for all of debtor’s assets - the place of filing distinction between tangible and intangibles assets has been eliminated (See Revised § 9- 301 (for security interests perfected by filing, while a debtor is located in a jurisdiction, the local law of that jurisdiction governs perfection)).
         1. For a “registered” entity, the place to file is the place of organization (See Revised § 9-307(e)(“A registered organization that is organized under the law of a State is located in that State”)). This results in a corresponding headache for searchers: try looking for financing statements filed against IBM in New York (although not as much of a headache as looking everywhere IBM had tangible assets under old Article 9).
         2. For a non-registered organization, debtor is located “at its place of business” (See Revised § 9-307(a) & (b)).
      2. Secured parties may use “supergeneric” descriptions of collateral in financing statements (although not in security agreements). Can you use a supergeneric description even when a blanket lien is not intended? (See Revised § 9-502(a)(3) (“a financing statement is sufficient only if it . . . indicates the collateral covered by the financing statement); § 9-504 (“A financing statement sufficiently indicates the collateral that it covers if the financing statement provides (1) a description of the collateral pursuant to Section 9-108; (2) an indication that the financing statement covers all assets or all personal property; § 9-108 (“must reasonably identify what is described”) (Comment: Under Section 9-504, a financing statement sufficiently indicates the collateral if it covers “all assets or all personal property”));
      3. There is a two-tier “error rule” for irregularities in financing statements:
         1. Only three types of error are fatal against a § 544(a) challenge by the bankruptcy trustee:
            1. debtor’s name;
            2. creditor’s name;
            3. description of collateral (See Revised § 9-502(a)).
         2. There are additional requirements for the financing statement to be accepted by the filing office (See Revised §§ 9-516(b) & 9-520(a) (financing statement must indicate debtor’s jurisdiction of organization, the type of organization, and organizational ID. If accepted by filing office, however, notwithstanding omissions, the financing statement is deemed valid - but can be subordinated to a secured party or purchaser who reasonably relies on the incorrect information -- but not the bankruptcy trustee. (See Revised § 9-338(a) & (b)).
   2. Revised Article 9 streamlines a debtor’s ability to securitize assets. Revised Article 9 enhances the certainty of asset purchasers concerning how to perfect their interests.
      1. What formerly were general intangibles (income producing assets that did not fall within old § 9-106 definition of the “account”) are now Revised § 9-102(a)(2) “accounts” and thus interests in them may be perfected by filing.
      2. Also included within Revised Article 9's scope are sales of chattel paper, promissory notes, payment intangibles - providing clarity as to how to perfect an interest in them, and thus rendering transfers protected from the bankruptcy trustee’s “strong arm.”
4. Revised Article 9 makes it easier to protect secured creditors from bankruptcy trustee’s “strong arm” by providing for two different levels of perfection in some types of collateral: a lower level that protects the secured creditor from defeat by the bankruptcy trustee, and a higher level that protects secured creditor’s interest from the interests of all other competitors.
   1. Deposit accounts can be perfected by “control” (See Revised § 9-104) but secured party is vulnerable to defeat by the bank in which the account is held’s right of set-off. A secured creditor that has established “control” over a deposit account is fully secured against the trustee in bankruptcy.
   2. With respect to instruments, a secured creditor can perfect a security interest in an instrument by filing, and such perfection is good against the bankruptcy trustee’s strong arm. (See Revised § § 9-312(a), 9-317(a)(2), 9-322(a) & 9-330(d)). Security interests in instruments must be perfected by possession, to fully establish priority over a competing secured creditor.
5. Remedies available to secured creditors shift balance of power between secured creditors and debtors:
   1. New strict foreclosure rule allows foreclosing secured creditor to both retain (accept) the collateral in partial satisfaction of debtor’s obligations, and go after debtor for any deficiency. (See Revised § 9-620(a)).
   2. Revised Article 9 makes the remedy of strict foreclosure available for both tangible as well as intangible collateral. (See Revised § 9-620(a)).
6. Revised Article 9 allows secured creditors to encumber a reorganizing debtor’s cash collateral, thereby thwarting reorganization efforts.
   1. Upon a debtor’s bankruptcy, an estate is created which includes property encumbered by security interests. (See 11 U.S.C. § 541). The more encumbered assets debtor has, the fewer assets available for payment to unsecured creditors.
      1. Expanded proceeds definition means that more post-petition assets are proceeds, rather than after-acquired collateral (which is cut off in bankruptcy - see Part II. C. above).
      2. More encumbered assets also means there are fewer assets available for collateral substitution, in the event the court wants to offer “adequate protection” in connection with a cash collateral order (See 11 U.S.C. § 363). Secured creditors are entitled to receive the “value” of their security interest - and the court may order a collateral substitute or some other interest that is the “indubitable equivalent.” (See 11 U.S.C. § § 361(3) & 363(e)).
      3. The changes in Revised Article 9 making it easier to encumber with security interests more types of assets will result in fewer assets available for reorganization, as well as for residual creditors.
   2. Debtor’s bankruptcy estate does not generally include property the debtor has sold in connection with a securitization. (See Revised § 9-318(a)). Accordingly, the transferred assets are not subject to the automatic stay or turnover orders. But Article 9 does not determine the sale v. loan issue in bankruptcy - it remains an equitable determination.
      1. A debtor in bankruptcy’s cash flow from its securitized receivables will be unavailable to debtor in connection with its reorganization efforts. The cash flow may be necessary to pay employees, trade creditors, consumer claims and to generally keep debtor afloat during the pending reorganization.
      2. The changes in Revised Article 9 making it easier to securitize more types of assets with greater certainty will result in fewer assets available for reorganization, as well as for residual creditors.