In Re Kevin M. Stanton in Re: Maryann G. Stanton, Debtors. Gregory Beeler, Appellant-Cross-Appellee v. Harrison Jewell, Fka International Factors, Inc., Appellee-Cross-Appellant
Docket: 00-35474
Court: Court of Appeals for the Ninth Circuit; April 9, 2002; Federal Appellate Court
The case involves a dispute over lien priorities stemming from the bankruptcy of Kevin and Maryann Stanton. International Factors, Inc. (now represented by Harrison Jewell) had a security interest in Fleet Manufacturing, a corporation owned entirely by the Stantons. In 1994, International Factors secured its interest by taking a lien on the Stantons' house and the Stantons personally guaranteed Fleet's obligations. Following increased financing needs due to a large order from K-Mart, the Stantons filed for Chapter 11 bankruptcy while International Factors continued to provide funds based on the existing lien.
In May 1996, the bankruptcy was converted to Chapter 7, leading to the sale of the Stantons' house by the bankruptcy trustee. International Factors sought to claim the sale proceeds based on its lien. The trustee filed an action to avoid this lien, arguing it was invalid since the Stantons had encumbered estate assets without court authority after Fleet incurred additional debt post-bankruptcy filing.
The bankruptcy court initially sided with the trustee, but the Bankruptcy Appellate Panel (BAP) reversed this decision, asserting that the lien had been established prior to the bankruptcy and that the subsequent financing did not create a new lien requiring court approval. The Ninth Circuit Court of Appeals affirmed the BAP's ruling, emphasizing that Fleet, as a separate legal entity, was not in bankruptcy and thus did not necessitate court oversight for its financial dealings after the Stantons filed for bankruptcy. The court concluded that the lien on the Stantons' house was valid and could not be avoided by the trustee.
The trustee contends that the automatic stay provision under 11 U.S.C. § 362 prevented the factor from advancing funds to Fleet. Violating this automatic stay can result in significant penalties, including punitive damages and contempt sanctions. Lenders may be deterred from extending credit to corporations with bankrupt shareholders due to the risk of these penalties. However, § 362(a)(4), which halts actions to create or enforce liens against estate property, does not apply here; lending money to a non-bankrupt debtor does not constitute such an act. A mere ownership interest in a corporation does not extend the automatic stay to its non-bankrupt shareholders.
The lien on the Stantons' house was established prior to the bankruptcy filing through a second mortgage. Any subsequent advances by the factor simply altered the amount secured by that existing lien, rather than creating a new one. The Bankruptcy Appellate Panel clarified that 11 U.S.C. § 364(c), which permits the trustee to encumber estate assets with court approval, is irrelevant since the house was already encumbered before bankruptcy and the factor did not lend to the Stantons themselves. Fleet, being non-bankrupt, did not need court approval to incur debt. While the Stantons would need approval for additional secured debt, they did not incur any.
Moreover, the factor's lien did not renew with each advance; it was secured by a deed of trust covering all future indebtedness to Fleet, which is a common practice. This arrangement allows for efficient financing, as it avoids the need for multiple refinancings or additional mortgages for future advances, benefiting both the borrower and lender. The initial conveyance of property interest is intended to serve as comprehensive security for future performance under the mortgage agreement.
Washington law recognizes that a mortgage for future advances establishes an effective lien from the time of recordation, rather than at the time of each advance. This principle was affirmed in John M. Keltch, Inc. v. Don Hoyt, Inc. Additionally, the factor's discretion to make subsequent advances plays a crucial role in lien priority. Optional advances made by a factor, like International Factors to Fleet, do not create new liens but can result in junior liens in relation to intervening claims, particularly in bankruptcy situations, where the factor's lien became subordinate to the bankruptcy trustee’s claims for advances made post-bankruptcy filing.
The Bankruptcy Appellate Panel (BAP) remanded the case for the bankruptcy court to determine the distribution of sale proceeds from the Stantons' house, with International Factors cross-appealing, arguing they should receive all proceeds since their claim exceeded the amount available. The BAP noted that the bankruptcy court had not yet addressed the validity of International Factors' lien under relevant bankruptcy statutes and deemed the remand necessary to resolve outstanding issues. Consequently, the BAP's decision was affirmed.
Debtors, acting as trustees, did not seek to obtain credit or incur debt postpetition; rather, all relevant agreements and lien perfection occurred before the bankruptcy filing. The factor's advances to Fleet, a separate entity, did not create new liabilities for the Debtors since the existing lien on the Property was established prior to bankruptcy. The dissent argues that the bankruptcy court improperly allowed Fleet to incur additional debt without court approval, but this overlooks that neither Fleet nor the factor had the authority to request a § 364(c) approval in the Debtors' bankruptcy case. The Stantons' home was already encumbered before filing for bankruptcy, and its use as collateral for Fleet's debts did not constitute new encumbrance post-filing. The dissenting opinion contends that the majority misinterpreted Washington's lien law and misapplied federal bankruptcy law, advocating for reinstating the bankruptcy court's summary judgment in favor of the trustee. The Stantons owned Fleet Manufacturing and entered multiple agreements with International Factors, including a Factoring Agreement allowing the creditor to purchase accounts receivable. They also signed a Guaranty, making them personally liable for Fleet's debts, and a Deed of Trust on their home to secure those obligations.
On September 30, 1994, the debtors filed for Chapter 11 bankruptcy, which was converted to Chapter 7 on May 11, 1996. Following this conversion, the trustee sold the debtors' residence, prompting a creditor to seek attachment of the sale proceeds based on a lien from a Deed of Trust. The trustee initiated an action on September 26, 1996, to avoid these liens due to post-petition transfers, resulting in competing motions for summary judgment. The bankruptcy court granted the trustee's motion.
The Bankruptcy Appellate Panel (BAP) later reversed this decision, with one dissenting opinion. The BAP majority concluded that under Washington law, a lien for future advances is established at the time of recording and thus existed prior to the bankruptcy filings. They further ruled that the encumbrances did not violate 11 U.S.C. § 364, as they benefitted Fleet rather than the debtors.
However, the dissenting opinion argued that the BAP misinterpreted Washington law and that the post-petition advances further encumbered the debtors' estate, violating § 364. The bankruptcy court had established that once bankruptcy was filed, the debtor could not further encumber estate assets without court permission. The estate included all of the debtor’s legal and equitable interests as of the bankruptcy filing.
The text notes that 11 U.S.C. § 362 imposes an automatic stay against actions to create or enforce liens on estate property post-filing, while § 364 provides limited exceptions for obtaining credit with court approval. The creditor's argument, that no new lien was created since the debt was incurred by Fleet, a non-bankrupt entity, was contested as failing to align with the protective intent of § 364 and the definition of 'debt' relevant to the need for court permission.
Judge Perris's dissent emphasizes that under 11 U.S.C. § 364(c), the debtors’ use of their house as collateral for Fleet's post-petition debts required prior court approval, which was not obtained. The bankruptcy code defines 'debt' as a liability on a claim, and 'claim' encompasses rights to payment or equitable remedies. The debtors’ actions increased their liability on creditor's claims by using their house as collateral, thus incurring new debt that necessitated court authorization. The majority's argument that no new encumbrance occurred due to a preexisting lien misinterprets Washington law, which recognizes new liens from optional advances made after the bankruptcy filing.
Furthermore, the majority's analysis of § 364 fails to consider the bankruptcy code's definitions of 'debt' and 'claim,' which clarify potential violations. Since there was no court hearing for approval of the increased debt, the creditor cannot claim that the bankruptcy court allowed the additional debt secured by liens. The dissent holds that the further encumbrance of the estate post-petition violated the automatic stay under § 362(a), which prohibits any act to create or enforce liens against the bankruptcy estate's property. The stay is effective immediately upon filing, and any liens created or perfected after the petition are void, although pre-petition liens remain unaffected by the stay.
The determination of when the liens were created is governed by state law, specifically under Washington law, which indicates that liens from optional advances become effective at the time of each advance. The Factoring Agreement specifies that the advances are optional, meaning the creditor is not obligated to purchase any account and can decline purchases at their discretion. As such, new liens arose post-petition to secure these advances, necessitating bankruptcy court approval since they affect the debtors' estate.
The creditor argues that under 11 U.S.C. § 348(d), claims arising before the conversion from Chapter 11 to Chapter 7 should be treated as pre-petition claims, implying that any automatic stay violations in Chapter 11 become irrelevant post-conversion. However, precedent from the Johnson case and the Eleventh Circuit’s analysis in British Aviation Insurance Co. indicates that the automatic stay under § 362(a) remains in effect regardless of case conversion. The courts have emphasized the importance of the automatic stay as a fundamental debtor protection, and any change in bankruptcy chapter does not negate prior violations of this stay.
Consequently, because the creditor's continued encumbrance on the bankruptcy estate violated the automatic stay during the Chapter 11 proceedings, the liens created from the optional advances are deemed void. The decision of the Bankruptcy Appellate Panel (BAP) is to be reversed, and the bankruptcy court's order granting the trustee’s motion for summary judgment should be affirmed.
Debtors signed most agreements as representatives of Fleet but executed the Deed of Trust and Guaranty as personal guarantors. The Deed of Trust stipulates that filing for bankruptcy constitutes a default, indicating that the creditor was aware of the debtors' inability to fulfill obligations if they declared bankruptcy. The primary dispute arises from the interpretation of section 364, which allows a court to authorize a trustee to acquire secured credit under certain conditions, seen as an exception to section 362, which generally prohibits post-petition encumbrances on the bankruptcy estate. The majority's interpretation fails to adequately consider the implications of section 362 in understanding section 364.
The majority's position suggests that the approach would improperly pierce the corporate veil, concluding that debtors violated sections 362 and 364 by encumbering their house post-bankruptcy without court approval. It is emphasized that the house, part of the bankruptcy estate, could not be encumbered without obtaining such approval. Debtors benefit from bankruptcy protections, which prohibit encumbrances on the estate except as allowed by law. The rationale that encumbrances made for the benefit of a corporation rather than the debtors personally does not negate the requirement for court approval under bankruptcy laws.
The bankruptcy court found all pre-petition debts to the creditor had been fully paid. Although the creditor claims that Fleet's debt has not reached zero since the bankruptcy filing, it does not dispute the bankruptcy court’s findings regarding pre-petition debt. Continuous advances made by the creditor to Fleet do not contradict the finding that all pre-petition debt was settled; the disputed lien pertains to post-petition funding. Debtors filed for bankruptcy on September 30, 1994, having signed and recorded the Deed of Trust on July 28 and 29, 1994, respectively. The majority attempts to differentiate between lien priority and attachment under Washington law, a distinction that supports their ruling.
Case law does not differentiate between the priority of a lien and the date it attaches. The priority of a lien is determined by the date of its attachment or recordation. The precedent set in John M. Keltch, Inc. clarifies that for liens based on mandatory advances, the lien is effective from the time of recordation. However, for optional advances, the lien becomes effective upon recordation, not at the time of each advance. The common law regarding optional advances is broadly applicable, extending beyond construction liens, despite Section 60.04.226 of the Washington Revised Code, which pertains specifically to mechanics' and materialmen's liens. This section does not negate the general application of the optional advances rule in other contexts. Until there is a change from the Washington Supreme Court or legislature, the optional advances rule remains valid in Washington outside construction-related cases. Additionally, Section 348(d) states that claims against the estate arising after an order for relief but before conversion will be treated as if they arose immediately before the petition filing date.
