- Secured Creditor Loses Its Lien in Bankruptcy through Inattentiveness
- November 12, 2015 | Author: David E. Peterson
- Law Firm: Lowndes, Drosdick, Doster, Kantor & Reed Professional Association - Orlando Office
A sophisticated lender holding a mortgage or security interest usually knows that its secured status accords it special protections in a bankruptcy filed by the borrower. However, the limits of that protection are often a mystery to the lender. A lender who does not enlist the services of an experienced bankruptcy attorney immediately after the filing of the borrower’s bankruptcy may face a rude awakening when the lender later attempts to enforce its mortgage or security interest.
A recent appellate case illustrates the problem. In City of Concord, N.H. v. Northern New England Telephone Operations LLC, 795 F.3d 343 (2nd Cir. 2015), the City of Concord held tax liens on the debtor’s real estate. Although the City filed a proof of claim in the case, it neglected to contest confirmation of the debtor’s Chapter 11 plan of reorganization. The plan included boiler-plate language stating that upon confirmation, the property of the debtor would be free of creditor’s interests, except as provided in the plan. Even if the plan had not included such a provision, the Bankruptcy Code provides for the same result. No exception was provided in the plan for the City’s tax liens. When the City attempted to enforce its tax liens more than two years later, the appellate court ruled that the boiler-plate provision effectively deprived the City of its liens.
Had the City made timely objection to the plan, the bankruptcy court would likely have denied confirmation or required the debtor to amend its plan to specifically preserve the City’s liens. Section 1129 of the Bankruptcy Code states that the court may not confirm a plan unless all secured creditors either accept the plan or the debtor meets the “cramdown” requirements of section 1129(b), which require the plan to provide for retention of or the “indubitable equivalent” of the secured creditor’s lien. However, it often does not come to the attention of the judge that the plan does not meet these requirements unless the creditor objects. If the plan is confirmed and no timely appeal is filed, then the provisions of the plan become binding on the secured lender, including the provision that deprives the lender of its lien.
The court in City of Concord held that in order for the City to lose its lien, it was required to have “participation” in the bankruptcy proceedings. That requirement was added by the courts because of the recognition that loss of a creditor’s lien is harsh, and is usually the result of inattentiveness rather than any deliberate strategy by the creditor. The City argued that the boiler-plate language was “vague,” and that it was the debtor who drafted the plan, and it therefore should not be permitted to take advantage of vague provisions. However, the court found that the City’s filing of proofs of claim in the case was sufficient to show that the City participated in the bankruptcy, and therefore, the debtor’s property was free of the City’s tax lien after confirmation. The court stated that “creditors have a responsibility to take an active role in protecting their claims.”
The result was harsh. The City lost its lien, even though the Bankruptcy Code specifically precluded the court from confirming the plan unless the lien was preserved. Thus, the error seems to lie as much with the debtor and the court as with the creditor. Nevertheless, it is the result provided in the Bankruptcy Code, and it was up to the City to protect its own rights.
Although City of Concord involved a tax lien, the same rule of law applies to the holder of a mortgage on real estate or security interest in personal property. A secured lender does enjoy a higher level of protection in a bankruptcy than does an unsecured creditor, but the protection is not always automatic. The protection can be forfeited if the secured creditor does not actively monitor the proceedings and take action to protect its rights. That makes the assistance of an experienced bankruptcy attorney indispensable.