legal notes: THE LEGAL SIDE OF ABL & FACTORING

the cases we have selected for this issue address the lapse of a financing statement in a bankruptcy case and the importance of being named as "lender's loss payee" under casualty insurance policies.

American Bank, FSB v. Miller Bros. Lumber Co., Inc. (In re Miller Bros. Lumber Co.), 2013 U.S. Dist. LEXIS 152176 (M.D.N.C. October 23,2013) (United States District Court holds that the lapse of a financing statement after the filing of a Chapter 11 case will not render the security interest voidable.)

On October 25, 2006, Miller Brothers Lumber Co., Inc. (the "Debtor") entered into an equipment Master Lease, as lessee, with American Bank, FSB ("American"). American filed a UCC-i Financing Statement on October 27,2006. Nearly five years later, on September 9, 2011, the Debtor filed for bankruptcy protection under Chapter 11. Under Article 9 of the North Carolina UCC, a financing statement is effective for five years after the date of filing, and a financing statement lapses after five years unless the creditor has filed a UCC-3 Continuation Statement within six months prior to the date the financing statement is set to expire. U.C.C. § 9-515.

American's financing statement, which was in effect at the time of the Chapter 11 filing, lapsed on October 27, 2011 during the bankruptcy case, as American did not file a continuation statement. After the lapse, American filed a proof of claim as a secured creditor, and later filed a motion for adequate protection and to modify the automatic stay in an attempt to take possession of the equipment subject to its lien. The Debtor opposed the motion. The Bankruptcy Court denied American's request for relief, holding that American's failure to file a continuation statement permitted the Debtor under section 544 of the United States Bankruptcy Code to avoid American's security interest. American appealed the decision to the District Court, which reversed the Bankruptcy Court's decision.

The District Court held that under section 544 of the Bankruptcy Code, a Chapter 11 debtor is granted the status of a judicial lien creditor as of the commencement of the Chapter 11 case, and therefore has the ability to avoid the transfer of the Debtor's property to a third party to the same extent as a judicial lien creditor. The Court then framed the issue as whether the Debtor, as a hypothetical judicial lien creditor, could trump American's now-lapsed security interest, even though American was properly perfected as of the date of the petition.

The Court held that, while the Debtor derives its powers as a judicial lien creditor from the Bankruptcy Code, the UCC governs the priority of security interests. The District Court reviewed section 9-515(0) of the UCC, which deals with the lapse of a financing statement. Under that section, according to the District Court, upon a lapse, a financing statement is deemed never to have been perfected only against a purchaser of the collateral for value. Importantly, however, the UCC does not address the possible change in priority relative to any junior lien interests, such as to that of a judicial lien creditor.

The District Court reasoned that Article 9 of the UCC in effect prior to its 2001 revision, which specifically addressed the priority issue with regard to junior lien interests in the event of a lapse, was instructive. Under the UCC in effect prior to 2001, a lapsed security interest would be deemed to have been unperfected as against a party who became a purchaser or lien creditor before the lapse. Revised Article 9 removed "lien creditors" from the list of those against whom the security interest would be deemed never to have been perfected. This indicated, according to the District Court, that under the revised Article 9, a secured party was intended to maintain priority over a judicial lien creditor, so long as the security interest had been perfected prior to the time the judicial lien arose, as required under section 9-3l7(a) of the UCC.

Accordingly, the District Court held that American's failure to file a continuation statement did not result in a loss of priority against the Debtor's lien arising under section 544 of the Bankruptcy Code. American's security interest would have been deemed to never have been perfected against a purchaser of the collateral for value, but American's security interest was deemed to be perfected when the Debtor's hypothetical judicial lien arose, and so American retained priority under 9 317(a) of the UCC.

While the result was favorable for American, simply filing a continuation statement is a more prudent way of ensuring perfection and avoiding litigation.

Westfield Ins. Co. v. Talmer Bancorp, - Fed.Appx. 2013 WL 5812027 (6th Cir. Oct. 30,2013) (Sixth Circuit confirms that a secured lender named as "loss payee" is not afforded certain rights available to a "lender's loss payee" under its borrower's insurance policy as a result of its borrower's fraud.)

In March 2008, Milan 2000 Furnishings, Ltd., a furniture retailer, claimed that burglars vandalized its warehouse and stole inventory. Milan then made a claim for recovery to its insurance provider, Westfield Insurance Company, for losses in respect of the damaged real property and stolen personal property. Milan's insurance policy with Westfield showed People's State Bank as "loss payee" with respect to inventory and "mortgagee" with respect to the warehouse. Westfield, suspecting fraud, requested sworn proof of loss statements from Milan. Milan submitted its claim and proof of loss statements indicating that People's State Bank was a mortgagee, but that no party held a security interest in the stolen inventory. Westfield ultimately concluded its investigation and issued two checks, one check to cover the damage to real property jointly payable to Milan and People's State Bank and one check to cover the stolen inventory payable only to Milan.

Talmer Bancorp, as successor to People's State Bank, learned of the insurance payment in respect of stolen inventory and demanded that Westfield re-issue the check naming it as joint payee as a result of its status as a "loss payee" under the policy. Westfield refused and sought a declaratory judgment stating that it owed no insurance proceeds. Westfield argued that Milan's fraudulent representation about the bank's interest voided the policy. The district court agreed with Westfield and entered ajudgment deeming the policy void and requiring Milan to pay Westfield the amount of insurance proceeds it received in respect of the stolen inventory.

The Sixth Circuit confirmed the district court's judgment. According to the court, Milan's admitted fraud terminated the policy in accordance with its terms and, accordingly, terminated the bank's right to recovery. Unlike a "mortgagee" or "lender's loss payee," the policy gave "loss payees" no independent right of recovery if the insured breached the terms of its policy. Rather, as a "loss payee," the lienholder is "simply an appointee to receive the insurance fund to the extent of its interest" and a breach by the insured prevents any recovery by the lienholder. Westfield, 2013 WL 5812027 at * 2.

This case highlights the subtle, but important, distinction between naming a secured creditor as a "loss payee" and a "lender's loss payee" under an insurance policy. Insurance companies may have several reasons to void a policy relative to the insured, including fraud, intentional destruction of property and failure to provide timely proofs of loss. However, a "lender's loss payee," as opposed to simply a "loss payee," is afforded additional protections under the insurance policy and is generally able to enforce the policy even if the policy is voided as a result of such actions by the insured.tsl

This case highlights the subtle, but important, distinction between naming a secured creditor as a "loss payee" and a "lender's loss payee " under an insurance policy.

JONATHAN HELFAT AND RICHARD KOHN

CFA CO-GENERAL COUNSEL

Jonathan N. Helfat, partner, Otterbourg P.C., and Richard M. Kohn, partner, Goldberg Kohn, are CFA co-general counsel.