Bank and Judgment Creditor Slug it Out over Priority Interest in Bank Account

The United States District Court for the Northern District of Illinois, Eastern Division, recently analyzed the priorities of the competing interests of a judgment creditor and a bank in a debtor’s bank account. See One CW, LLC v. Cartridge World North America, LLC, 2009 WL 3055337 (N.D. Ill. September 18, 2009). One CW recovered a judgment in the amount of $359,279.00 against Cartridge World Midwest, LLC (“Midwest”). Seven days later, Midwest pledged all of its assets to Signature Bank as a guarantee on two pre-existing personal loans made by the president of Midwest in the amount of $500,000 and $150,000 respectively. Signature Bank filed a UCC-1 Financing Statement with the Minnesota Secretary of State’s Office perfecting the security interest in Midwest’s assets.

Several months later, One CW issued citations (also known as garnishee interrogatories) to Signature Bank. Signature Bank disclosed that Midwest owned an account with the bank. The account held $81,573.28. One CW argued that Signature Bank was barred from asserting a priority interest in Midwest’s assets, including the bank account, because Signature Bank failed to exercise its rights to those assets under its security agreement with Midwest.

Signature Bank declared Midwest to be in default on the day Signature Bank was served with the citation. However, Signature Bank did not take consistent actions to pursue its rights and remedies resulting from Midwest’s default. The court found most significant the fact that Signature Bank only froze Midwest’s assets for 5 days before allowing Midwest to resume unencumbered use of the account. Signature Bank unfroze Midwest’s account because the president of Midwest assured Signature Bank that Midwest was attempting to resolve the dispute with One CW. Signature Bank appeared to have decided not to enforce its rights and remedies under the terms of the security agreement and did not take steps to enforce its rights with regard to Midwest’s assets. Since Signature Bank had opted not to exercise its rights and remedies in the face of Midwest’s default, Signature Bank “[did] not have a present right to the funds” held in Midwest’s account “nor a basis on which to object to their release.”

The lesson to be learned from the bank’s missteps is that a bank must consistently enforce its rights under a security agreement in order to avail itself of the priorities afforded by its security agreement. In quoting the Eighth Circuit, the court stated that a third-party lender cannot, consistent with the UCC, “refuse to exercise its rights under the security agreement, thereby maintaining [the borrower/judgment debtor] as a going concern, while it impairs the status of other creditors by preventing from exercising valid liens.”