The Uniform Commercial Code and Bankruptcy

Paper by Robert Leon Poster

To a commercial lawyer, the mention of bankruptcy and the Uniform Commercial Code in one sentence strongly suggests a series of well-known problems—principally the problems relating to the need to perfect security interests under Article 9 of the U.C.C. in order to prevent the bankruptcy trustee from disregarding the security interest under section 544 of the Bankruptcy Code. Admiralty lawyers may tend to think of an entirely different series of problems when they hear the word bankruptcy—such as which part of the federal district court, admiralty or bankruptcy, administers the property with which they are concerned. Nevertheless, the specter of bankruptcy requires that admiralty lawyers become familiar with the uncertain boundaries between admiralty jurisdiction and ordinary commercial law, including the U.C.C., which governs many common maritime business transactions, lest a bankruptcy trustee complete their education for them. The admiralty practitioner must know the answers to two related questions: (1) what must be done in common commercial shipping transactions so that, under the Uniform Commercial Code, the rights of creditors are not inadvertently lost to the bankruptcy trustee; and (2) in which transactions must attention be paid to Uniform Commercial Code principles as well as, if not in lieu of, traditional admiralty procedures?

As far as many admiralty practitioners are concerned, the starting point for discussing perfected rights in bankruptcy formerly was sections 67(b) and 67(c) of the old bankruptcy law, and is now section 545 of the Bankruptcy Code, which reads in pertinent part:

§ 545. Statutory liens.

The trustee may avoid the fixing of a statutory lien on property of the debtor to the extent that such lien—

. . .

(2) is not perfected or enforceable at the time of the commencement of the case against a bona fide purchaser that purchases such property at the time of the commencement of the case, whether or not such a purchaser exists . . . .

Inquiry starts with that section because the maritime liens they seek to enforce arise under the Maritime Lien Act. Claims so arising are likely to be categorized as ‘statutory liens' for the purposes of Bankruptcy Code section 545 quoted above. The term ‘statutory lien’ is defined in section 101(45) of the Bankruptcy Code as follows:

(45) ‘statutory lien’ means lien arising solely by force of a statute on specified circumstances or conditions, or lien of distress for rent, whether or not statutory, but does not include security interest or judicial lien, whether or not such interest or lien is provided by or is dependent on a statute and whether or not such interest or lien is made fully effective by statute . . . .

Thus, to the extent that maritime liens are ‘secret’ liens recognized under the Maritime Lien Act and enforceable against bona fide third party holders of the property, they may not be avoided by the bankruptcy trustee under section 545, and the lienor will find it advantageous to claim this origin for his lien.

Of course, many liens do not arise in this fashion. They are consensual liens, based on an agreement, and assuming that they are in fact liens, a different Bankruptcy Code provision is applicable. Let us take the example of a typical assignment by a shipowner to a bank of the shipowner's earnings under a charter. Commercial lawyers would generally consider this a consensual lien on such earnings, a security interest in the shipowner's account arising under Article 9 of the U.C.C., to be perfected by filing. To avoid this lien in a bankruptcy the trustee would look to Bankruptcy Code section 544:

§ 544. Trustee as lien creditor and as successor to certain creditors and purchasers

(a) The trustee shall have, as of the commencement of the case, and without regard to any knowledge of the trustee or of any creditor, the rights and powers of, or may avoid any transfer of property of the debtor or any obligation incurred by the debtor that is voidable by—

(1) a creditor that extends credit to the debtor at the time of the commencement of the case, and that obtains, at such time and with respect to such credit, a judicial lien on all property on which a creditor on a simple contract could have obtained such a judicial lien, whether or not such a creditor exists;

(2) a creditor that extends credit to the debtor at the time of the commencement of the case, and obtains, at such time and with respect to such credit, an execution against the debtor that is returned unsatisfied at such time, whether or not such a creditor exists;

. . .

(b) The trustee may avoid any transfer of an interest of the debtor in property or any obligation incurred by the debtor that is voidable under applicable law by a creditor holding an unsecured claim that is allowable under section 502 of this title or that is not allowable only under section 502(e) of this title.

The result of section 544(a), as most law students are taught, is to refer us to section 9-301(1)(b) of the U.C.C., which in essence provides that a person who becomes a lien creditor before the security interest is perfected has priority. Section 544(a) and Article 9 thus dovetail, and unless a secured party has perfected his interest before the date of filing of the bankruptcy petition, he will lose to the bankruptcy trustee, except insofar as section 9-301(2) permits later perfection to relate back in the case of purchase money security interests.

Let us consider some typical shipping transactions, conducted pursuant to the Uniform Commercial Code, which might require examination in light of Bankruptcy Code section 544: (1) the assignment to a secured creditor of charter hire, freights, and the like; (2) the right of a secured creditor in insurance or other proceeds under sections 9-306 and 9-312 of the U.C.C.; and (3) the assignment to a secured creditor of (a) cash, (b) Treasury bills, (c) certificates of deposit, or (d) uncertified deposits. It might be helpful if we can imagine a situation in which these types of transactions are involved—a typical bank loan secured by an assignment of the earnings of a vessel. Let us hypothesize that, as part of a loan transaction in which a bank loans money to a shipowner secured by a mortgage on his vessel, the earnings of the vessel are assigned to the bank; the charterer is instructed to pay directly to the bank; the bank is to set up a collateral account into which such earnings are to be paid (as well as the proceeds of other collateral such as insurance); from this account the shipowner is to receive certain amounts (with the remainder to be used to pay down the loan or to be held as security); insurance is assigned to the bank which is made loss payee with the proceeds to go through the collateral account; and the shipowner is given the right within specified limits to direct the bank to invest the funds held in the collateral account. As we all know, this investment is the one most pressing reality governing all the arrangements just outlined. Let us further hypothesize that the shipowner wants to grant a second lien in this collateral to another lender or service provider who agrees to be subordinated to the bank. All of these arrangements are described in the documents pursuant to which the loan is made—documents which purport to give the bank, and the junior pledgee, a perfected security interest (lien) in all the above property, not subject to avoidance under section 544 of the Bankruptcy Code. Do they?


About the Author

Robert Leon Poster. J.D. 1965, L.L.M. 1966, Harvard Law School; Member of the Bar, New York City.

Citation

59 Tul. L. Rev. 1361 (1985)