From the Bankruptcy Courts: the Rt Ustee's Avoiding Powers and Conditional Attachment Liens-Can Two People Wear the Same Shoes? Benjamin Weintraub

Maurice A. Deane School of Law at Hofstra University Scholarly Commons at Hofstra Law

Hofstra Law Faculty Scholarship

1989 From the Bankruptcy Courts: The rT ustee's Avoiding Powers and Conditional Attachment Liens-Can Two People Wear the Same Shoes? Benjamin Weintraub

Alan N. Resnick Maurice A. Deane School of Law at Hofstra University

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Recommended Citation Benjamin Weintraub and Alan N. Resnick, From the Bankruptcy Courts: The Trustee's Avoiding Powers and Conditional Attachment Liens- Can Two People Wear the Same Shoes?, 22 UCC L.J. 88 (1989) Available at: https://scholarlycommons.law.hofstra.edu/faculty_scholarship/835

This Article is brought to you for free and open access by Scholarly Commons at Hofstra Law. It has been accepted for inclusion in Hofstra Law Faculty Scholarship by an authorized administrator of Scholarly Commons at Hofstra Law. For more information, please contact [email protected]. From the Bankruptcy Courts Benjamin Weintr{lub* and Alan N. Resnick**

THE TRUSTEE'S AVOIDING Nazario caused a preliminary writ POWERS AND CONDITIOf\IAL of attachment to be levied against ATTACHMENT LIENS-CAN TWO certain equipment and proceeds PEOPLE WEAR THE $AME because the debtor was not served SHOES? personally with the summons and A recent case in the Southern complaint. District of New York, In re De On May 11, 1984, another Lancey ,.1 raises interesting ques creditor, United. States Fidelity & ~ions about a lien obtained by writ Guaranty Company (USF&G), of attachment when a bankruptcy filed fimincing statements under petition is filed before the lienor Article 9 of the Uniform Commer obtains a money judgment against cial Code to perfect a security the debtor. interest in the assets of Mr. and DeLancey, the individual debtor, Mrs. DeLancey. The financing was the principal of a corporation statements, as well as ajudgment involved in the. roofing business in note, were filed as a result of Allentown, Pennsylvania. In April USF&G's issuance of payment 1984, Nazario, a creditor of both and performance bonds on behalf the corporation and DeLancey, of the debtor and the corporation. commenced an action against Mr. When various creditors sued and Mrs. DeLancey and the cor both the debtor and the corpora poration in federal district court to tion in October 1984, the state · collect unpaid debts for materials court ordered that certai~ equip furnished. On the same day, ment be sold and the proceeds held in escrow by a bank pending a determination of the relative * Counsel to the law firm of Levin & rights in the assets. On March 13, Weintraub & Crarnes, New York City; 1985, the Pennsylvania court held member of the National Bankruptcy. Con ference. that DeLancey, not the corpora ** Benjamin Weintraub Distinguished tion, was the owner of the equip Professor of Bankruptcy Law, Hofstra ment that was sold. The proceeds University School of Law, Hempstead, New York; Counsel to Berkman, Henoch, of the .sale held in escrow were Peterson, Kadin, Peddy & Scarcella, Gar only $44,217, which was less than den City, New York; Member of the Na the amount owed to Nazario and tional Bankruptcy Conference. 1 Case No. 85-B-20100 (S.D.N.Y. only a small fraction of the sum Dec. 20, 1988) (slip op.). owed to USF&G. 88 FROM THE BANKRUPTCY COURTS

DeLancey filed a bankruptcy clause, because the lien·was "no petition commencing a chapter 7 perfected" in that it ~as condi liquidatiop. case on March 5, 1985. tional on obtaining a money'judg At that time, Nazario's attach ment that cannot be .obtained ment lien had priority, under because of the bankruptcy. Thus, Pennsylvania law, over the sub the attachment lien ~ssolved and, sequently perfected lien of according to the trustee's argu USF&G. If bankruptcy had not ment, the trustee niay preserve ensued and Nazario had eventu the attachment lien fot the benefit ally obtained a money judgment in of the estate under Section 551.of its action, Nazario's priority over the Code.4 The result of this rea USF&G would have enabled soning, according to the trustee, is Nazario to collect the entire es that the trustee stands in the prior crow fund. However, state law ity position of Nazario and defeats provides that a lien obtained by the junior security interesf of order of attachment is inchoate USF&G. and condit'ional on obtaining a Summary judgment was denied money judgment. If a judgment in part bec~use of factual issues cannot be obtained, the condi that had ·to be resolved, but the tional lien is dissolved. 2 Under bankruptcy court granted partiat these facts, what are the relative summary judgment to the extent rights of the parties as to the pro that the bank was directed to tum ceeds of the equipment held in the over the escrow funds to the escrow fund? trustee.5 Although the co~rt did gard to any knowledge of the trustee, or Relative Rights of the Parties of -any creditor, the ri&hts and powers of, or may avoid any transfer of prop This question was first raised in erty of the debtor or any obligation in curred by the debtor that is voidable by the context of a motion for sum (1) a creditor that e)(tends credit to the mary judgment by the trustee in debtor at the time of the commencement connection with his turnover ac of the case, and that obtains, at such time and with respect to such credit, a tion against the bank to recover judicial lien on all property on which a the escrow funds. The trustee ar creditor on a simple contract could have gued that Nazario's attachment obtained such a judicial lien, whether or not such a creditor exi~ts .... lien was voidable under Section 4 544(a)(l) of the Bankruptcy 11 U.S.C. 551 provides: 3 Any transfer avoided under section 522, Code, the· so-called strong-arm 544, 545, 547; 548, 549, or 724(a) of this title, or any lien void 'under section 2 See In re Savidge, 57 Bankr. 389, 391 506(d) of this title, is pres~rved for the· (D. Del. 1986). benefit of the estate but only with re 3 11 U.S.C. § 544(a) provides: spect to property of the estate. The trustee shall have, as of the com sIn re DeLancey, 77 Bankr. 424 mencement of the case, and without re- (S.D.N.Y. 1987).

89 UNIFORM COMMERCIAL CODE ~AW JOURNAL [VOL. 22 : 88 1989] not resolve the priority dispute promoting the priority of un between the trustee and USF&G, avoidable junior secured interests it did confirm that Nazario's lien who would otherwise improve was inchoate or unconditional be tpeir positions at the expense of cause it did not obtain a money the estate. " 6 judgment. The court pointed out, how In a subsequent· motion to re ever, that the trustee's rights re classify the claim ofUSF&G as an sulting from preservation of the unsecured claim, the trustee again avoided lien are not without lim took the position that Sections itation. 5M(a)(l) and 551 allow the trustee [T]he trustee who avoids and then to avoid the "unperfected" in preserves a senior secured claim choate attachment lien while pre cannot acquire greater rights in the serving it for benefit of the estate, property in question than those to thereby giving the trustee priority which the ~rustee succeeded .... over USF&G's lien. Thus, when under state law, the In response, USF&G argued avoided lien which is sought to be that the inchoate or conditional at.: preserved is inferior to subsequent tachment lien of Nazario is dis valid liens, the inferior lien cannot solved and therefore unavailable be enhanced by its preservation for preservation under Section under 11 U.S.C. § 551. If the avoided lien will sink below other 551. USF&G contended that the liens ~gainst the estate, the trustee trustee is .subrogated under Sec who stands in the shoes of the in tion 551 to the unsecured status of ferior avoided Jien will likewise Nazario's inch~ate or conditional sink whjle in those shoes, because lien which was "unperfected" 11 U.S.C. § 551 does not create a and dissolved because no money floating lien for trustees. 7 judgment was entered in favor of Nazario prior to bankruptcy. Focusing on the status of Since the trustee may not pre Nazario's attachment lien on the serve Nazario's lien for the ben date on which tl;te debtor filed the efit of the estate, according to bankruptcy petition, which is USF&G' s argument, its perfected when the trustee's strong-arm security interest became the powers arise under Section senior lien that is effective against 544(a), the bankruptcy court con the trustee. cluded that Nazario held a "valid The bankruptcy court noted unperfected attachment lien that the rationale behind the au which was superior to USF&G's tomatic preservation of avoided liens pursuant to Section 55i is that "the estate should benefit 6 In re DeLancey, slip op. at 6. from eacli avoidance rather than 7 Id.

90 FROM THE BANKRUPTCY COURTS subsequent in time lien which was· taining a money judgment after perfected by filed UCC Financing bankruptcy, the attachment lienor Statements.'' 8 will "perfect" the lien and the at The conclusion, that Nazario's tachment lienor's priority will lien had priority over USF&G's date back to the prebankrqptcy security interest under Pennsyl time when the attachment lien vania law led to the next question: was first obtained. Thus, upon What effect did the bankruptcy such perfection the attachment petition have on the attachment lien becomes unavoidable as lien? against the trustee. Moreover, Section 362(b)(3) provides an ex: Effect of Bankruptcy. Petition on ception to the automatic stay to Attachment Lien permit postpetition perfection of a lien to the extent that the trustee's The bankruptcy court found the avoiding powers are subject to district court decision in In re Section. 546(b). Savidge 9 helpful in its analysis. The district court in Savidge re The attachment lien in Savidge jected these arguments and held was inchoate when the debtor that the bankruptcy discharge of filed a bankruptcy petition and a the debt owed to the attachment subsequent judicial lien creditor, lienor made it impo~sible for the not the trustee, objected to the se lienor to ever obtain a money cured status of the attachment judgment against the debtor. lienor in the bankruptcy case. The Therefore, the inchoate .attach attachment lienor argued that Sec ment ·lien could never be per tion 546(b) of the Code allowed it fected and, under state law, it dis to "perfect" the inchoate attach solved. The attachment lienpr ment lien after the debtor filed the must be treated as an unsecured bankruptcy petition. Pursuant to creditor. The district court also Section 546(b), the trustee's held that Section 546(b) was inap avoiding powers under Sections plicable to perfection of an at 544, 545, and 549 of the Code are tachment lien designed solely to "subject to any generally applica secure jurisdiction. ble law that permits perfection of an interest in property to be effec We hold that this type of unper tive against an entity that acquires fected lien, created by ITI's writ_ of rights in such property before the domestic attachment in order to date of such perfection.'' By ob- compel the appearance of the de fendant and · wholly dependent upon the subsequent recovery of a judgment on the attachment pro 8 ld. at 7. 9 In re Savidge, 57 Bankr. 389 (D. Del. cess, is not the type of "interest in 1986). property" which can be perfected

91 UNIFORM COMMERCIAL CODE LAW JOURNAL [VOL. 22 : 88 1989]

under Section 546(b) after the tied to a discharge of any debts debtor files for bankruptcy. 10 because of his failure to keep or The bankruptcy court in De preserve records>from which his Lancey did not discuss the rejec financial condition might be ascer tion of the Savidge holding by the tained and for failure to explain 14 Court of Appeals for the Ninth satisfactorily a loss of assets. Circuit in In re Wind Power Sys Therefore, Nazario was free to tems, Inc.U The court of appeals obtain a money judgment after the stated as follows: bankruptcy case and, once ob tained, the attachment lien would [T]he Savidge opinion cites no case ripen into a judgment lien that law in support of its conclusion, would have priority over and the logic of its application by USF&G's security interest and the bankruptcy court would also the trustee's hypothetical judicial overturn a strong line of cases in lien created by Section 544(a)(l). this ~ourt allowing prepreference Although the bankruptcy court lien creditors to proceed to judg did not mention Section 546(b), ment [citations omitted) .... As a that section should leave no doubt matter of policy, the Savidge result is undesirable. Had the Savidge that the trustee's rights under creditor been allowed to proceed to the Section 544(a)(l) strong-arm judgment, it would have taken clause are subject to Nazario's priority over the trustee's judicial ability to perfect the inchoate at lien. The bankruptcy court's result tachment lien by obtaining the ·provides an incentive for strategic postpetition judgment. Moreover, bankruptcy filings which distort the automatic stay should not rights among creditors from what interfere with Nazario's action to they would be outside bankruptcy obtain the judgment because of 12 proceedings. the exception contained in Sec The bankruptcy court in De tion 362(b)(3). Lancey, by not following the The court in DeLancey correct Wind decision, in essence rejected ly held that the trustee may not the court of appeals's view that a use Section 551 to preserve "conditional attachment" ·lien Nazario's attachment lien for the could be effective even if the un benefit of the estate and to reduce derlying claim is discharged. In a USF&G's status to that of an un previous decision, 13 the court secured creditor. "In the event held that DeLancey was not enti- that Nazario obtains a judgment against the nondischarged debtor, 10 ld. at 391. such lien will ripen into a vested 11 841 F.2d 288 (9th Cir. 1988). lien to the extent of the attached 12 841 F.2d at 293. 13 In re DeLancey, 58 Bankr. 762 (S.D.N.Y. 1986). 14 See 11 U,S.C. §§ 727 (a)(3), 727(a)(5).

92 FROM THE BANKRUPTCY COURTS funds. Manifestly, the trustee may state law. If permitted to do so, not stand in Nazario's shoes to the trustee would dance very 9efeat perfected lien creditors nicely in those shoes to reduce who are junior to Nazario." 1 s USF&G to unsecured creditor status. The shoes would fit well. Conclusion It is more accurate to say that the Bankruptcy Code limits the Although we agree with the trustee's right to wear 1Nazario's court's holding and analysis, we shoes to ascertain whet)ler or not nonetheless question the meta they fit. Since Nazario may con phor used by the court to explain tinue to pursue a judgment to its reasoning: "perfect" its lien; and ,the ripened Unfortunately for the trustee, lien will have priority over a Nazario's shoes are too large for hypothetical judicial lien creditor his feet. . . . Although the trustee who obtained the judicial lien on has attempted to try on Nazario's the date of bankruptcy, there is no shoes in order to preserve assets basis under the Code for avoid for the benefit of unsecured credi ance of Nazario's lien unless tors, this court finds that the shoes Nazario fails to obtain .a judg don't fit. This finding is consistent ment. In essence, the trustee's with the old maxim that the same strong-arm power under Section shoe does not fit every foot. 16 544(a)q) does not provide the But we believe th~t Nazario's strength needed to remove shoes would fit the trustee. The Nazario from its shoes. If there is denial of discharge means that no basis for avoiding the lien Nazario could and would continue under the Code, Section 551 has to recover a money judgment no application and does,not allow against DeLancey regardless of the trustee to preserve the lien for the existence of the attachment the benefit of the estate. Whether lien. Even unsecured creditors or not Nazario's shoes fit the pursue judgments against a non trustee, the trustee may not wear discharged debtor. In any event, them as long ,as Nazario is still once a money judgment is ob wearing--them. tained, the attachment lien would Perhaps a more accurate pic have priority over USF&G's per ture of the court's reasoning in fected security interest under DeLancey could have been paint ed with the comment that "one ts In re DeLancey, slip op. at 10. pair of shoes cannot be worn by 16 ld. two people at the same time."