California Bankruptcy Court Holds Junior Lienholder Liable for Payments Debtors Made to Senior Lienholder as Preferential Transfers

by Snell & Wilmer
Contact

Section 547 of the Bankruptcy Code allows a bankruptcy trustee to recover transfers from creditors that are labeled “preferences.” To avoid a transfer as a preference, the trustee must generally demonstrate that the transfer: (1) was of an interest of the debtor in property, (2) was made to or for the benefit of a creditor, (3) was made on account of an antecedent debt owed by the debtor, (4) was made while the debtor was insolvent, (5) was made within 90 days before the petition date (within a year if the creditor was an insider) and (6) enabled the creditor to receive more than the creditor would receive if the case were a case under chapter 7 and the transfer had not been made. Section 550 of the Bankruptcy Code then allows a trustee to recover the preferential transfer from the initial transferee, the immediate or mediate transferee of the initial transferee or the person for whose benefit the transfer was made.

Since 2001, the Ninth Circuit has held that pre-petition transfers to fully secured creditors are not preferential because “the secured creditor is entitled to 100% of its claims.” See In re Smith Home Furnishings, Inc., 265 F.3d 959, 964 (9th Cir. 2001). The Ninth Circuit noted that an exception from this rule may exist when a transfer changes the status of a creditor from being partially secured to fully secured at the time of the filing of the bankruptcy petition. Id.

Gladstone v. Bank of America (In re Vassau), 499 B.R. 864 (Bankr. S.D. Cal. 2013), represents a departure from the rule that a pre-petition payment to a fully secured creditor cannot be avoided as a preference. In Vassau the Debtors’ real property was subject to a first priority lien and a second priority lien in favor of Bank of America. Bank of America’s first priority lien was, at all times, fully secured, and its second priority lien was only partially secured. During the 90 days before the bankruptcy, Debtors made ten payments to Bank of America on account of its first priority lien. The Trustee sued Bank of America, in its capacity as the holder of the junior lien, to avoid the transfers because they benefited Bank of America by increasing the equity in the property that secured the junior lien. 

The Vassau Court granted the Trustee’s motion for summary judgment, stating that the payments: “which would otherwise be available to unsecured creditors ha[ve] been removed from their reach to the benefit of the Junior Lienholder.” The decision ultimately rested on two things. First is the way the Court approached section 547(b)(5), which inquires whether the transfer enabled the creditor to receive more than it would receive if the case were a case under Chapter 7. The Court sided with other circuits and used the “simple hypothetical liquidation” approach. Under it, the property would be liquidated, the senior lienholder would be paid in full, and the remaining proceeds would be paid over to the junior lienholder. Had the payments not been made, “the secured claim of the Senior Lienholder would be larger” by the amount of the payments, less would be available to the junior lienholder on its secured claim, and the amount of the unsecured claim would be greater. Thus, the payments resulted in the junior lienholder receiving more in the chapter 7 case than it would had the payments not been made. Second, the Vassau Court held that the payments could be recovered from Bank of America in its capacity as the second lienholder because it received the benefit of the transfers.

The court’s opinion in In re Vassau raises a number of questions. For instance, would the result have been different if the lienholders were different? The Vassau Court’s interpretation of Bankruptcy Code section 550 suggests that the result would not have been different if the lienholders were separate entities. Vassau also arguably eviscerates Smith Home Furnishings in cases where multiple creditors have liens against the same collateral by opening the door for trustees to allege that payments made to the senior lienholder were preferential to the undersecured junior lienholder and then recover the transfer from the senior lienholder because it was the initial transferee.   

Moreover, if a trustee elects under Bankruptcy Code section 550 to recover from a junior lienholder, it is unclear whether a junior can seek an award from the senior lienholder for the value of the amount received. Similarly, it is unclear whether a junior lienholder can preemptively avoid disgorging money it never received by asking the court to marshal the award, thereby forcing the trustee to recover from the senior lienholder. Vassau offers no guidance on these issues.  

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© Snell & Wilmer | Attorney Advertising

Written by:

Snell & Wilmer
Contact
more
less

Snell & Wilmer on:

Readers' Choice 2017
Reporters on Deadline

"My best business intelligence, in one easy email…"

Your first step to building a free, personalized, morning email brief covering pertinent authors and topics on JD Supra:
Sign up using*

Already signed up? Log in here

*By using the service, you signify your acceptance of JD Supra's Privacy Policy.
Privacy Policy (Updated: October 8, 2015):
hide

JD Supra provides users with access to its legal industry publishing services (the "Service") through its website (the "Website") as well as through other sources. Our policies with regard to data collection and use of personal information of users of the Service, regardless of the manner in which users access the Service, and visitors to the Website are set forth in this statement ("Policy"). By using the Service, you signify your acceptance of this Policy.

Information Collection and Use by JD Supra

JD Supra collects users' names, companies, titles, e-mail address and industry. JD Supra also tracks the pages that users visit, logs IP addresses and aggregates non-personally identifiable user data and browser type. This data is gathered using cookies and other technologies.

The information and data collected is used to authenticate users and to send notifications relating to the Service, including email alerts to which users have subscribed; to manage the Service and Website, to improve the Service and to customize the user's experience. This information is also provided to the authors of the content to give them insight into their readership and help them to improve their content, so that it is most useful for our users.

JD Supra does not sell, rent or otherwise provide your details to third parties, other than to the authors of the content on JD Supra.

If you prefer not to enable cookies, you may change your browser settings to disable cookies; however, please note that rejecting cookies while visiting the Website may result in certain parts of the Website not operating correctly or as efficiently as if cookies were allowed.

Email Choice/Opt-out

Users who opt in to receive emails may choose to no longer receive e-mail updates and newsletters by selecting the "opt-out of future email" option in the email they receive from JD Supra or in their JD Supra account management screen.

Security

JD Supra takes reasonable precautions to insure that user information is kept private. We restrict access to user information to those individuals who reasonably need access to perform their job functions, such as our third party email service, customer service personnel and technical staff. However, please note that no method of transmitting or storing data is completely secure and we cannot guarantee the security of user information. Unauthorized entry or use, hardware or software failure, and other factors may compromise the security of user information at any time.

If you have reason to believe that your interaction with us is no longer secure, you must immediately notify us of the problem by contacting us at info@jdsupra.com. In the unlikely event that we believe that the security of your user information in our possession or control may have been compromised, we may seek to notify you of that development and, if so, will endeavor to do so as promptly as practicable under the circumstances.

Sharing and Disclosure of Information JD Supra Collects

Except as otherwise described in this privacy statement, JD Supra will not disclose personal information to any third party unless we believe that disclosure is necessary to: (1) comply with applicable laws; (2) respond to governmental inquiries or requests; (3) comply with valid legal process; (4) protect the rights, privacy, safety or property of JD Supra, users of the Service, Website visitors or the public; (5) permit us to pursue available remedies or limit the damages that we may sustain; and (6) enforce our Terms & Conditions of Use.

In the event there is a change in the corporate structure of JD Supra such as, but not limited to, merger, consolidation, sale, liquidation or transfer of substantial assets, JD Supra may, in its sole discretion, transfer, sell or assign information collected on and through the Service to one or more affiliated or unaffiliated third parties.

Links to Other Websites

This Website and the Service may contain links to other websites. The operator of such other websites may collect information about you, including through cookies or other technologies. If you are using the Service through the Website and link to another site, you will leave the Website and this Policy will not apply to your use of and activity on those other sites. We encourage you to read the legal notices posted on those sites, including their privacy policies. We shall have no responsibility or liability for your visitation to, and the data collection and use practices of, such other sites. This Policy applies solely to the information collected in connection with your use of this Website and does not apply to any practices conducted offline or in connection with any other websites.

Changes in Our Privacy Policy

We reserve the right to change this Policy at any time. Please refer to the date at the top of this page to determine when this Policy was last revised. Any changes to our privacy policy will become effective upon posting of the revised policy on the Website. By continuing to use the Service or Website following such changes, you will be deemed to have agreed to such changes. If you do not agree with the terms of this Policy, as it may be amended from time to time, in whole or part, please do not continue using the Service or the Website.

Contacting JD Supra

If you have any questions about this privacy statement, the practices of this site, your dealings with this Web site, or if you would like to change any of the information you have provided to us, please contact us at: info@jdsupra.com.

- hide
*With LinkedIn, you don't need to create a separate login to manage your free JD Supra account, and we can make suggestions based on your needs and interests. We will not post anything on LinkedIn in your name. Or, sign up using your email address.