Dana Aprigliano
St. John's University School of Law
American Bankruptcy Institute Law Review Staff
In In re Main Street Business Funding, LLC, the Bankruptcy Court for the District of Delaware held that a creditor asserting a perfected security interest in funds the debtor recovered from two settlements could not recover these funds because their collateral did not include assets received from tort litigation.[1]
On February 1, 2016, John P. Lane (“Creditor”) purchased a promissory note (“Note”) in the amount of $852,500 from Main Street Funding (“Debtor”).[2] In return for the Note, Creditor received a security agreement (“Agreement”) from the Debtor granting blanket liens in Creditor’s favor.[3] As such, the Agreement defined the term “proceeds” to have its meaning under the Uniform Commercial Code (“UCC”) as well as “whatever is realized upon the use, sale, exchange, license, or other utilization of or any disposition of the Collateral . . . whether cash or non-cash, and all proceeds of the foregoing.”[4] On June 21, 2018, Creditor perfected his security interest.[5] On July 22, 2019, Creditor filed a proof of claim against the Debtor in the amount of $852,500.[6]
The Debtor’s primary assets were proceeds of two settlements.[7] The underlying litigations were brought by Debtor’s estate to recover damages from an alleged scheme certain defendants implemented.[8] The underlying complaints asserted claims for fraudulent misrepresentation, conversion, civil conspiracy, unjust enrichment, breach of fiduciary duty, aiding and abetting breach of fiduciary duty, and legal malpractice.[9] The Creditor alleged all of the aforementioned settlement proceeds were subject to his lien and therefore recoverable by him in bankruptcy because the claims litigated and settled were breach of contract, not tort, claims, and his collateral under the Agreement included proceeds of all the Debtor’s contracts.[10] Still, in deciding the issue, the Court determined it must also analyze whether, even if the claims sounded in tort, the collateral description in the Agreement was specific enough to include the settlement money.[11]
First, to determine whether the claims sounded in breach of contract or tort, the Court analyzed the “gist of the action” doctrine.[12] This doctrine bars plaintiffs from “re-casting ordinary breach of contract claims into tort claims.”[13] Applying this bar to each cause of action, the Court found that out of eleven claims only two sounded in breach of contract.[14] For example, the Court found that the fraudulent misrepresentation claims sounded in tort due to their arising from fraudulent acts, not out of contractual duties.[15] On the other hand, the Court determined the two counts of breach of fiduciary duty to be tort claims because the fiduciary duty at issue went beyond the parties’ contractual obligations.[16] Accordingly, given that nine of the claims sounded in tort, the “gist of the action” was in commercial tort, and Creditor was unable to collect the funds recovered therefrom on the grounds of their resulting from contract claims.[17]
Second, the Court found that the collateral description was not specific enough to include commercial tort claims since the description failed to mention the litigation by name or reference, including the words “commercial tort claim,” or any “facts that might identify the state court action.”[18] Additionally, general intangible clauses such as that in the Agreement do not include commercial tort claim proceeds not in existence at the time of an encumbrance.[19] Here, the claims arose after the effective date of the Agreement.[20] Since the collateral description was not specific enough to include commercial tort claims, especially those arising after the effective date of the Agreement, Creditor was unable to collect on the grounds the collateral description somehow included the commercial tort claim settlement proceeds.[21]
At the end of its opinion, the Court distinguished this case from others in which secured creditors were permitted to recover, particularly the Eight Circuit's decision in Bayer CropScience, LLC v. Stearns Bank National Association.[22] It distinguished Bayer on the grounds that the commercial tort at issue there involved damage to equipment that was in fact the creditor's collateral, whereas the commercial tort at issue here did not.[23] The Court concluded that because the “gist of the action” was in commercial tort and the collateral description in the Agreement could not include the settlement proceeds regardless, the Creditor could not prevail on his allegations.[24]
[1] See In re Main St. Bus. Funding, LLC, 642 B.R. 141, 154 (Bankr. D. Del. 2022).
[2] Id. at 146.
[3] Id.
[4] Id.
[5] Id.
[6] Id.
[7] See id.
[8] See id.
[9] Id. at 147.
[10] Id.
[11] See id. (“The Trustee responds that [Creditor]’s argument fails for two reasons. First . . . the estate claims . . . are commercial tort claims . . . Second . . . the causes of action did not exist at the time of execution of the [Agreement].”).
[12] Id. at 148.
[13] Id. (quoting Brown & Brown, Inc. v. Cola, 745 F. Supp. 2d 588, 619 (E.D. Pa. 2010)) (citation omitted).
[14] Id. at 152.
[15] Id. at 149.
[16] See id. at 151 (quoting Rahemtulla v. Hassam, 539 F. Supp. 2d. 755, 779 (M.D. Pa. 2008)).
[17] Id. at 152.
[18] Id. at 152–53.
[19] Id. at 153.
[20] Id.
[21] Id.
[22] Id. n.70.
[23] Id.
[24] Id. at 154.