Citizens Bank & Trust v. Security First Insurance Holdings, LLC (In re Brooke Capital Corp.)

Citizens Bank & Trust v. Security First Insurance Holdings, LLC (in re Brooke Capital Corp.), __ Fed. Appx. __, 2014 WL 6873180 (10th Cir. December 8, 2014)
In a priority dispute between lenders, those holding participation interests in a loan secured by stock were subject to the recharacterization of their participation interest as loans, which rendered their claims unsecured security interests subordinate to claim of a competing lender.
Procedural context:
Bankruptcy court ruled that one lender had superior rights in collateral (the sale proceeds of stock) as against the claims of competing creditors who held participation interests in a loan to the debtor. The district court reversed, finding that the participation creditors held assigned perfected security interests which could not be defeated. On further appeal, the 10th Circuit ruled that that the participation interests were subject to recharacterization and that the participation certificates granted the participants a security interest in payment and general intangibles that was itself subject to the perfection requirements of the UCC. As the participants did not themselves perfect their security interests, they were subordinated to that of the lender with a perfected interest. Reversed. [Note: not a published decision]
In 2007, the debtor received a $12 million loan from a subsidiary that was secured by a stock pledge of the debtor's interest in another subsidiary. At the same time, the debtor also obtained a $9 million loan from a bank. The first subsidiary thereafter sold fractional interests (or "participations") in its loan to other entities. During subsequent workout discussions with the bank, the debtor represented to the bank that the first subsidiary would release its lien on the second subsidiary's stock so that the bank would receive payment from the sale of the second subsidiary. The executed payment agreement provided that any proceeds which the debtor or the first subsidiary might otherwise be entitled to receive from the sale would instead be paid to the bank. Only after execution of the agreement did the bank learn of the participation interests. After that, the debtor filed bankruptcy. In the bankruptcy court, the participants and the bank fought over priority of their interests in the proceeds of the stock sale. The bankruptcy court found that the bank's claim was clearly superior to that of the first subsidiary; more importantly, because the participation agreements should be recharacterized as loans, instead of true participations, the particiants could not rely on the first subsidiary's perfected security interest to protect their claims. As such, the court ruled in favor of the bank. On appeal, the district court found that because the participation agreement expressly characterized the transaction as an assignment of a portion of the first subsidiary's interests, no additional perfection was required to protect the participants, and reversed. On further appeal, the 10th Circuit Court of Appeals ruled that recharacterization of security interests under Article 9 of the UCC requires a court to look beyond the language of the agreement to determine the true nature of the interest granted. Here, the participants received security interests in both a payment and a general intangible; their interests terminated upon payment of their loan by the first subsidiary. The first subsidiary did not truly assign its own security interest and the participants did not perfect their interests. The bank's security interest had priority. Reversed.
Kelly, Lucero, and Matheson

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