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Thelma McCoy v. USA

Summarizing by Craig Geno

Velde v. Border State Bank (In re HovdeBray Enterprises)

Citation:
Case No. 12-6035 (BAP 8th Cir. 2012)
Tag(s):
Ruling:
In this preference action by the chapter 7 trustee, the BAP held that perfection of Border State Bank's (the "Bank") lien was within the preference period under Section 547(b) and that the floating lien defense under Section 547(c)(5) did not provide a defense to a security interest that was actually perfected during the preference period. The BAP also held that the mutually agreed liquidation of the debtor's business and subsequent payoff of the debtor's loan from the Bank was not "ordinary course", nor did the Bank's release of funds constitute "new value". The BAP further held that the Bank was not entitled to a credit against the $242,824.04 judgment in favor of the trustee for $1,403.07 in consulting fees incurred by the Bank.
Procedural context:
In this preference action under Section 547 by the chapter 7 trustee, the Bank appealed the bankruptcy court's ruling denying the Bank's motion for summary judgment, which had asserted a number of defenses to the preference action. The BAP affirmed the bankruptcy court's ruling in all but one aspect. On that aspect, which involved giving the Bank a credit for its expense of hiring a consultant to analyze the Bank's best strategy, the BAP reversed the bankruptcy court's ruling. There was also a cross-appeal by the trustee with respect to the Bank's ability to setoff the funds on deposit when the bankruptcy was filed and the credit allowed the Bank for its consulting fees.
Facts:
In 2007, the Bank made an operating loan of $350,000 to the debtor to permit the debtor to purchase inventory for its Ben Franklin store. The debtor granted the Bank a security interest in essentially all of its personal property, including inventory, accounts, fixtures, and proceeds. The Bank did not file a financing statement with the Minnesota Secretary of State's office at that time. Subsequently, due to concerns about the debtor's business, the Bank engaged a consultant to analyze the status of the debtor's business. The debtor then stopped making payments. By mutual agreement, the debtor and the Bank agreed that the debtor would retain a liquidation service and conduct a going-out-of-busines sale. The Bank then filed its UCC financing statement with the Secretary of State on July 13, 2010, for the first time perfecting its lien in the inventory, accounts, fixtures, and proceeds. All proceeds from the sale went into the debtor's account at the Bank. Gross proceeds from the sale were $426,571.79. Of those funds, $256,672.02 went to pay the Bank's note in full. An additional $6,403.07 was paid to the Bank as reimbursement for the liquidation company. After other expenses, the debtor had $41,353.15 remaining. Also, as of July 13, 2010, the balance in the debtor's deposit account was $13,579.98. The Bank asserted that it had setoff rights to this account, regardless of whether it had a validly perfected security interest in other assets of the debtor. The debtor filed a chapter 7 petition on October 11, 2010. The Bank first asserted that it had a "floating lien" or "inventory/accounts receivable" defense under Section 547(c)(5), which defense was the subject of its summary judgment motion. The court observed that Section 547(c)(5) generally provides a defense to a creditor which holds a floating lien - i.e. one that automatically attaches to inventory and receivables acquired by an obligor after the loan is made. A limitation to this defense is the "improvement of position" test. Under this test, if a creditor begins the preference period undersecured and, as a result of after-acquired inventory and receivables, the amount of the deficiency is subsequently reduced, the floating lien defense is not available. The Bank asserted that it was fully secured at the beginning of the preference period (July 13, 2010) and, therefore, did not improve its position during the preference period. The court stated that the Bank missed the first step in asserting the Section 547(c)(5) floating lien defense - namely the need to prove that it held a validly-perfected floating lien which automatically attached to the debtor's inventory. Citing the Eighth Circuit's decision in In re Qualia Clinical Service, Inc., 652 F.3d 933 (8th Cir. 2011), the court emphasized that a creditor who, like the Bank, "enters the test period unperfected is properly deemed, for purposes of Section 547(c)(5), to have an interest of zero value." The court noted that the perfection in this instance was, itself, a voidable preference. The court further stated that the fact that the Bank perfected its security interest during hte preference period cannot be used to bootstrap itself into asserting that it did not improve its position during that period. Consquently, the Section 547(c)(5) floating lien defense was not available to the Bank. Next the court considered the Bank's "ordinary course of business defense". The Bank did not take issue with the bankruptcy court's conclusion that payment from the liquidation was not ordinary course. The Bank asserted that payments were made pursuant to a store closing agreement between the parties and made according to ordinary business terms. The Bank further argued that the terms of the contract were customary for this type of liquidation situation. Accordingly, the Bank argued that the payments were made "according to ordinary business terms" under Section 547(c)(2)(B). The court summarily dismissed the Bank's argument, noting that it failed to see how payment in full from a going-out-of-business sale resulting in the cessation of business itself could be considered ordinary course in any business or industry. Next the court considered the Bank's argument under Section 547(c)(4) that it had a new value defense. The Bank argued that it replenished the debtor's estate by the sum of $6,403.07 as payment to the liquidation company and some $164,000 in funds released from the account in which it had setoff rights to allow the debtor to conduct the going-out-of-business sale in an attempt to maximize revenue. The court acknowledged that Section 553 does provide that an account with setoff rights is a secured claim in a bankruptcy case. However, agreeing with the bankruptcy court, the BAP held that the liquidation proceeds transferred into the debtor's account at the Bank were transferred within the preference period while the debtor was insolvent and for the express purpose of satisfying the entire antecedent debt to the Bank. Citing In re Kroh Bros. Development Co. v. Commerce Bank of Kansas City, N.A., 86 B.R. 186, 191-92 (Bankr. W.D. Mo. 1988), the court noted that "the setoff exception does not apply where a deposit is accepted by a bank with an intent to apply it on a preexisting claim against the depositor...If either depositor or the bank intends that a deposit may not be withdrawn but must be used to satisfy the bank's claim, the deposit constitutes a voidable preference when other elements of [Section 553] are met." In the instant case, the court conclucded that since the purpose of the liquidation, and deposit into the account, was to pay the Bank's debt, the court properly found that the Bank did not obtain a setoff right against the liquidation proceeds. The court further concluded that the new value exception is not intended to apply to a situation where the creditor is, in effect, conducting a liquidation of the debtor so it can be paid in full. Next the court considered the trustee's cross-appeal on the issue of the Bank's setoff rights against the debtor's account on the 90th day prior to the bankruptcy filing. The court stated that the issue was not whether the Bank setoff the funds on the 90th day; rather the proper focus must be on whether the Bank held a security interest in such funds at the start of the preference period, by virtue of its setoff rights under the loan documents and state law, and maintained a security interest until the funds were paid to it. The court concluded that since the Bank held a security interest in those funds, it did not receive a preference by receipt of such funds. Finally, the court considered the trustee's cross-appeal on the issue of the credit allowed the Bank for its consulting fees incurred for originally assessing the debtor's situation. The court observed that this was a service ordered by the Bank for the primary purpose of informing on the best chance it would have to recover on its entire indebtedness. The court held that the Bank should be required to pay for such services and that the bankrtupcy court had committed clear error in giving the Bank credit for that expenditure. In conclusion, the court found that the net amount of the preferential transfer was $244,227.11
Judge(s):
Federman, Venters, and Saldino

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