THE LOGIC OF BLANKET LIENS

<p>Law School Professor <person>Ronald Mann</person> explores the challenges secured creditors face in effectively taking a blanket lien and identifies new tools and measures secured lenders can take to better protect themselves when taking such liens.</p><p>It is an interesting time to be a student of commercial finance. When I began teaching, the law reviews were filled with articles debating every imaginable topic about secured credit: Is it good? Is it bad? Is it fair? Why do parties use it so often? Why don't they always use it? And on and on.</p><p>I wrote quite a bit about those topics in my early years as a scholar. But as the years went by, secured credit faded from scholarly attention. Younger scholars emphasized adjacent topics like bankruptcy or corporate finance. Yet, the last few years have seen a marked resurgence of interest in the field, with several scholars making substantial new contributions to the literature on the value and use of secured credit. As I work through that literature, I am struck more than anything by the oddity of some of the most basic assumptions that pervade the recent literature.</p><p>The most puzzling relate to blanket liens. A received wisdom seems to be developing that blanket liens are ineffective, at least as a matter of state law (as opposed to bankruptcy law). So, for example, <person>Ted Janger</person> argues in The Logic and Limits of Liens that the recoveries available to secured creditors holding blanket liens are so poor under state law that we should rethink the priority accorded secured creditors holding such liens in bankruptcy. In the same vein, <person>Michelle Harner's</person> The Value of Soft Assets in Corporate Reorganizations details the so-called "soft assets" that are so important to the going-concern value of businesses. In her view, the bankruptcy process need not allocate the value of those assets to secured creditors because they would not be able to reach them under the processes available for the creation and enforcement of security interests under state law.</p><p>I find all of this mystifying. It was my experience in practice, and has been my experience in my observation of the developing structures of secured transactions during my years as a professor, that the state legal systems and the transactional bar moved progressively through the years to improve the effectiveness of blanket liens. To be sure, as compared to half a century ago, we see a smaller share of the value on corporate financial statements coming from real estate, equipment, inventory, and accounts receivable. But that doesn't mean that lenders have no access to the sources of their borrowers' value. To the contrary, it means that they must develop new tools to protect themselves.</p><p>Meeting the Challenges of Modern Lending</p><p>If there is anything in this literature with which I agree, it is the description of how much harder it is to do a good job of taking a blanket lien now than it was justa few decades ago when <org>Congress</org> adopted the Bankruptcy Code. <person>Ted Janger</person> describes several of the pitfalls that await attorneys implementing the agreementof a borrower to grant a blanket lien. The lawyers might understand Article 9, but lack the more localized knowledge of the "vagaries" of parochial real estate law that often complicate the creation and perfection of interests in land, his discussion calls to mind the eccentric use of land trusts in <location value="LS/us.il" idsrc="xmltag.org">Illinois</location> real-estate lending. He also describes the multifarious occasions in which an Article 9 filing will need supplementation to reach the entirety of collateral - the need for control agreements, fixture filings, and the like. That discussion also resonates with my experience, in which the property most likely to "fall through the cracks" (his words) is intellectual property for which federal filings are necessary (or advisable) in addition to the state UCC filings.</p><p>But the variety and difficulty of those obstacles says nothing about the efficacy of blanket liens. To be sure, it suggests that the inadvertent blunders of inexperienced or unsophisticated counsel might leave lenders with a much narrower security interest than the one that their borrower offered. Indeed, even the most reputable firms often leave serious gaps in their documentation that expose their lending clients to disputes over the efficacy of their arrangements.</p><p>But there is nothing new in the role of bankruptcy courts in providing a"report card" on the quality of the lender's planning. The pattern of judicial secondguessing was already routine more than 80 years ago when <person>Justice Holmes</person> mulled the appropriate response to faulty documen- tation in Moore v. Bay. Then, as now, the centralization and specialization of the bankruptcy process often will facilitate the discovery of errors in transactional design and practice that otherwise might have gone unnoticed for decades. But a system in which those who plan poorly suffer for their lack of foresight sheds no light on the proper treatment of those who plan well.</p><p>The Limits of Liens</p><p>The concern about blanket liens is not, however, limited to the likelihood that lenders will fail to implement them well. Both Janger and Harner emphasize several sources of business value on which even well-advised lenders cannot take an effective lien. One group of issues relates to assets that are "unlienable." The classic example here is the liquor license; because the licensee cannot transfer the license to a third party, a grant of the license as collateral is at best evanescent. Another common "gap" between the lien and the sources of the business's value involves attributes that would not be considered property even under the most expansive conception of the term. Harner aptly describes the employment base of <org value="NYSE:LUV" idsrc="xmltag.org">Southwest Airlines</org>. I share Harner's view that these intangible, "infra-proprietary" relations can represent a substantial share of a firm's value. The point, for Janger and Harner at least, is that much of the business's value often will fall beyond the reach of the blanket lien.</p><p>For several reasons, that point does not persuade. The most important is its shortterm perspective. The h istory of Article 9, and of the lawyers that use it, is a history of steady broadening of the effective reach of the security interest. Consider, for example, the 1999 revisions to Article 9. By the time of the revision, the balance sheets of businesses, large and small, had come to depend in large part on assets to which Article 9 did not extend. Deposit accounts were available as collateral only under the antiquated "banker's lien," which was not as a practical matter available to third-party lenders. Securities accounts were not fully integrated into the Article 9 system. To say nothing of a whole host of financial assets now covered as payment intangibles, healthcare receivables and the like. Yet all of those assets have been swept not only into Article 9, but also into the routine coverage of blanket lending arrangements. There is every reason to think, as the decades go by and the common reservoirs of value shift, that the statute will be revised again (and again) to ensure that the interests it validates extend to all major classes of assets.</p><p>But that answer says nothing about the gaps that exist today, much less the more-or-less permanent problems of "unlienable" and "infra-proprietary" value. Thus, I endorse their view that, at any given time, there always will be some items of import to a business's success on which alendercannottakealien. Butl am not nearly so sure of the practical relevance of that point. For one thing, it seems most unlikely, for most firms, that their sources of value are dominated either by unlienable assets or infra-proprietary relationships. As Janger acknowledges - having reprinted the laundry list of Article 9 exclusions - the great majority of exclusions from Article 9 can be reached under other legal systems (the point of the discussion above). The remaining items are, truth be told, of no more consequence to the typical business than the liquor license.</p><p>Indeed, the only items of general application to businesses would appear to be commercial tort claims and insurance claims. But even those items will fall under the shadow of most well-documented blanket liens - either because the tort claims are proceeds of assets covered by the liens or because the lender as a matter of due diligence will deal with such matters when they arise, to ensure full access to the value of the tort claim or insurance policy.</p><p>I recognize the anecdotal character of that response. Moreover, I do agree that there are some businesses for which neither Article 9 nor any other extant legal regime can reach all the important sources of value. Even putting aside the wholly infra-proprietary matters that Harner discusses, consider the example of a car dealership chain. Let us suppose (what I believe to be true) that a lender cannot in any practical way ensure that a voluntary conveyance or involuntary foreclosure of the dealership's assets will include the state licenses necessary for the individual locations to operate. The lender that cannot get control of those licenses will have only fragile protection for its loans.</p><p>But the inability to reach that value directly does not mean that lenders are powerless to control it. On the contrary, when lenders observe importantsources of value outside the reach of routine lending strategies, they can respond by implementing any one of a number of transactional structures that ensure their ability upon default to gain access to the assets or relations in question.</p><p>The simplest is to interpose an entity between the operating business and the owners. The owners then grant a security interest in the ownership interests of the operating business. If forceful remedies are appropriate, the lender can use Article 9 to foreclose on the stock. Because that foreclosure would not shift the title of any assets of the operating business (lienable or otherwise), it should for the most part avoid the problems of gaining control of the non-transferable.</p><p>Avoiding the Costs of Piecemeal Liquidation</p><p>The last piece of the eulogy over the demise of the blanket lien emphasizes the stark wastefulness of a conventional foreclosure on the operating assets under Article 9 or the law of mortgages. Foreclosures on the real estate, repossession and auction of the equipment and inventory, the evaporation of accounts receivable, the considered annihilation of goingconcern value, all the horrors attendant on a forcible dismemberment of an operating business parade across the stage.</p><p>By comparison, the stately and considered process of the bankruptcy court can only be praised. In this narrative, piecemeal dismemberment of firms with substantial going-concern value is a stranger to the bankruptcy process. When firms retain operating profitability, they are sold rapidly, before the taint of insolvency permanently stains the enterprise.</p><p>That obsequy of destructive enforcement is a straw man. How often do lenders respond to default, even to protracted default, by a liquidating dismemberment under state law of a business that has prospects of operating profitably? On that point, as it happens, we do have some empirical evidence, albeit sketchy. And that evidence, not surprisingly, says that lenders' appreciation of the destructive costs of business foreclosures motivates them to avoid it like the plague (96 Mich. L. Rev. 159). Thus, lenders often bend over backwards to keep the doors of a business open rather than force the losses inherent in piecemeal liquidation.</p><p>That is not to say that lenders sit idly on their hands in the face of protracted nonpayment. Rather, it is to say that they design their collection strategies with an eye toward maximizing the return on their investment in the loan. To be sure, any description of the forcible exercise of state-law remedies against substantial businesses in the modern era is largely hypothetical; under the existing regime, any operating business on the brink of such a predicament is almost certain to seek refuge in bankruptcy.</p><p>What we do know about the use of those remedies suggests a set of outcomes much more sanguine than the developing wisdom suggests. Consider, for example, the natural experiment of technology companies in <location>Silicon Valley</location>. For reasons rooted at least in part in ill-reasoned decisions of the 9th Circuit (e g., 165 F.3d 747), technology companies for many years have avoided the bankruptcy process because of the likelihood that they would lose access to technology licenses during the process. Accordingly, in the common case when those businesses fail, those that have lent to or invested in them rarely use that process. As it happens, in <location value="LS/us.ca" idsrc="xmltag.org">California</location> at least, a separate ecosystem for reorganization of such firms has developed. Relying on <location value="LS/us.ca" idsrc="xmltag.org">California</location> statutes that support the "assignment for the benefit of creditors" (universally referred to as an <org>ABC</org>), it has remained true for decades that a substantial share of failing technology companies have chosen to use that process. By all accounts, the results of the <org>ABC</org> compare favorably with the results of the more conventional bankruptcy process (82 Wash. U.L.Q. 1375).</p><p>The unusual circumstances that have led to the development of that process underscore the broader point. We have no idea what sophisticated systems of liquidation and restructuring would look like under state law, because we live in a milieu in which almost all of that activity takes place in the bankruptcy court. I see nothing wrong with that, our bankruptcy courts provide a centralized and specialized system for business reorganization that is the envy of the developed world. We should, however, think twice before blindly accepting the idea that any restructuring of a business outside of the shelter of that court necessarily would resemble the bloodiest and most pointlessly destructive of the video games that occupy the minds and talents of ouryoungest generation.</p><p>In Praise of the Blanket Lien</p><p>At this point, I have said enough to make it clear that I see the blanket lien as an effective tool for the lending transactions that employ it. It is easy to decry the overweening control blanket lien holders can exercise in the bankruptcy process. But none of the developing wisdom, so far as I know, takes issue with the idea that the blanket lien is a useful and attractive product for those that select it. It is precisely that unbounded control that brings the enhanced reliability of recovery that the borrower offering a blanket lien can provide the lender. It is precisely the ability to underwrite not only the liquidation value of specific assets, but the cash flow of operating enterprises that makes the modern blanket lien such a substantial advance in lending technology. We should all take a collective step backward before we try to hamstring something that is so consistently the transaction of choice for the most sophisticated borrowers and lenders.</p><p>COMMISSION CALLS FOR REFORM OF CHAPTER 11</p><p><org>The American Bankruptcy Institute's</org> Commission to Study the Reform of Chapter 11 of the U.S. Bankruptcy Code issued a set of 241 wide-ranging recommendations in <chron>December 2014</chron>. A number of the recommendations could have a significant impact on the current rights of secured creditors in Chapter 11, particularly with regard to Adequate Protection, Absolute Priority, 363 Sales, DIP loans and small business bankruptcy. To learn more about the Commission's recommendations and how they could affect secured lenders, please go to <a href="http://www.cfa.com">www.cfa.com</a>.</p><p><person>Ronald Mann</person> is a professor of law at <org>Columbia Law School</org> specializing in commercial finance. He graduated from the <org>University of Texas Law School</org> in 1 985, clerked for Judge <person>Joseph Sneed</person> on the Ninth Circuit, and <person>Lewis Powell</person> on the <org>Supreme Court</org>, and served a stint at the <org>Office of the Solicitor General</org>, specializing in bankruptcy cases. He has been teaching at Columbia for the last eight years.</p>