Restructuring

Contributed by David G. Litvack
In In re Wilkinson, the United States Bankruptcy Court for the Northern District of New York recently held that a lender’s postpetition failure to file a UCC-1 continuation statement does not render the underlying security interest unperfected so long as the security interest was properly perfected as of the petition date.
In Wilkinson, the debtor owned and operated a cattle farm and executed a promissory note and security agreement with a lender in connection with the purchase and sale of cattle.  On March 30, 2006, the lender perfected its security interest by filing a UCC-1 financing statement covering the debtor’s personal property, including the debtor’s cattle.  On April 1, 2009, another creditor of the debtor, the Farm Service Agency (the “FSA”), filed a UCC-1 financing statement also covering the debtor’s cattle on account of amounts due and owing to it.  On August 16, 2010, the debtor filed for bankruptcy protection, and, thereafter, the debtor sold the cattle in which the lender and FSA asserted security interests.  The lender then asserted that its lien on the proceeds had priority over that of the FSA.
Section 9-515 of the New York Uniform Commercial Code (substantially similar in form and substance to the UCC) provides that a properly filed financing statement is effective for only five years.  Under the NYUCC, a continuation statement must be filed within the six month period prior to the expiration of the five-year period to prevent the lien perfection from lapsing.
In Wilkinson, the five-year period relating to the lender’s lien expired during the pendency of the debtor’s chapter 13 case.  Because the lender did not file a continuation statement prior to the expiration of its financing statement, the FSA argued that under New York law, the lender’s security interest became unperfected when the five-year period ran and that, accordingly, the FSA’s security interest in the proceeds had priority over the lender’s.  The FSA asserted that the intervening bankruptcy filing did not alter the requirement to file a continuation statement because section 362(a) of the Bankruptcy Code does not act as a stay to the filing of continuation statements.  As further support for this position, the FSA pointed to the 2001 amendments to the NYUCC.  Prior to the amendments, the NYUCC contained tolling language that specifically tolled the requirement to file a continuation statement during the pendency of a bankruptcy case.  After the amendments, however, the tolling language was stricken from the NYUCC.  Thus, the FSA argued that the NYUCC, as amended, requires a secured party to file a continuation statement to prevent the lapse of a financing statement regardless of any bankruptcy filing.
The Wilkinson court, however, was not persuaded by these arguments and held that the failure to file a continuation statement during a bankruptcy case is essentially irrelevant because the key date in determining parties’ respective security rights is the petition date.  The court agreed with the majority of courts that have held that a properly perfected security interest does not lapse on the expiration of the original financing statement if the expiration occurs during the pendency of a bankruptcy case.  Accordingly, the court ruled in the lender’s favor, finding that it held a first priority perfected security interest in the proceeds of the cattle.  The court rejected the FSA’s argument that New York law requires secured parties to file continuation statements during a bankruptcy to prevent a perfected security interest from becoming unperfected.  The FSA’s reading of the applicable statute, the court noted, was flawed in that it ignored a key sentence in the Comment to section 9–515(c) of the NYUCC.  The Comment specifically recognizes that bankruptcy law may “freeze” the parties’ interests at the time of a bankruptcy filing, and any postpetition lapse of a security interest is of no effect to a lender in a bankruptcy:

Of course, if the debtor enters bankruptcy before lapse, the provisions of this Article with respect to lapse would be of no effect to the extent that federal bankruptcy law dictates a contrary result (e.g., to the extent that the Bankruptcy Code determines rights as of the date of the filing of the bankruptcy petition).

Further, the court (and presumably the New York legislature) recognized that the tolling language in the pre-2001 version of the New York statute was unnecessary.  Specifically, section 362(b)(3) of the Bankruptcy Code authorizes the filing of a continuation statement against a debtor.  This section of the Bankruptcy Code, which obviates the need for a tolling provision in state law, thus enables a creditor to assure continued perfection of its security interest despite a debtor’s bankruptcy filing.  Interestingly, the Court did not explain why a lender should receive the benefit of continued perfection in a bankruptcy case even though the automatic stay does not prevent a lender from filing a continuation statement.
Although this case stands for the proposition that creditors are not required to file continuation statements during the pendency of a bankruptcy case, prudent practice certainly dictates that they do so anyway.  Congress has expressly authorized such action by way of section 362(b)(3) of the Bankruptcy Code.  The court wisely noted that the failure to properly file a continuation statement puts a creditor at risk that a debtor’s bankruptcy may be dismissed, thus leaving the creditor unperfected in many jurisdictions, including New York, when the protections of the Bankruptcy Code are removed.  The facts of Wilkinson parallel, in many ways, the Second Circuit’s decision in Avant Petroleum, Inc. v. Banque Paribas, which held that creditors’ rights to interpleader funds are determined as of the date the fund is created and a subsequent lapse of any applicable UCC financing statement will not affect such rights.  The Wilkinson case thus suggests that the reasoning in Avant Petroleum is equally applicable in a bankruptcy case.