By: Elizabeth Filardi
St. John's Law Student
American Bankruptcy Institute Law Review Staff
In Morris v. St. John National Bank,
the Tenth Circuit concluded that a bankruptcy trustee who successfully avoids a lien under the Bankruptcy Code does not automatically assume all the rights the original lienholder may have against the debtor.
[2]
Here, the debtors borrowed $3,050 from the bank, using their 1980 Pontiac Trans Am as security.
[3]
On the date the debtors filed for bankruptcy, they still owed the bank $3,237.50 on the loan, but the fair market value of the car was only $2,000.
[4]
The Trustee successfully avoided the bank’s lien on the car. While §551 preserved the lien for the benefit of the estate,
[5]
the issue was whether bankruptcy law permitted the trustee to recover the full amount owed or whether the trustee was limited to the value of the bank’s security interest in the car itself.
[6]
The Tenth Circuit concluded that a trustee who avoids a lien pursuant to 11 U.S.C §544 and preserves it under §551 is limited to the value of the lien and does not acquire the bank’s right to collect any debt amount beyond the value of the security interest.
[7]
Consequently, the trustee’s recovery was limited to the $2,000 value of the secured interest on the debtor’s car and could not recoup the full $3,237.50 value owed on the loan at the time of the bankruptcy filing.
Morris provides a useful determination of the limits of §551. Before the enactment of the Bankruptcy Code, liens generally passed through bankruptcy unaffected.
[8]
However, the Code created exceptions to this general rule. First, §544 afforded trustees the power to avoid “any transfer or obligation a creditor with an unsatisfied judicial lien on the debtor’s property could avoid under relevant state bankruptcy laws.”
[9]
Second, after the lien is avoided pursuant to §544, §551 provides that any transfer or lien avoided is preserved for the benefit of the estate.
[10]
Morris establishes that a contract promise to make future loan payments to a bank is “neither a lien nor any other transfer of interest in property.”
[11]
While §551 provides that the trustee in Morris could succeed to the bank’s in rem security interest in the car, the power to preserve “liens” and “transfers” does not embrace the bank’s unsecured right to receive loan payments above and beyond the value of the car.
[12]
Morris provides important insight into the line between property rights and mere contract rights. The court distinguished the contractual right to future payments on a loan from the independent and present property rights created by a lien.
[13]
This distinction rests on the fact that a “promise to pay” is technically a “personal obligation” while a lien “grants an interest in the property” and is “enforced against the [property].”
[14]
The distinction presented in Morris parallels the cases refusing to allow the trustee to use the §551 lien preservation power to assert rights under subordination agreements. The distinction between the property rights that §551 preserves for the trustee and the contractual rights that do not pass to the trustee is of critical importance in cases involving second lien financing, where the trustee avoids the senior lien but wishes to assert the priority rights established by a subordination agreement entered into between the senior and junior lienholders. Morris limits the trustee’s power and along with older cases like Robinson v. Howard Bank (In re Kors, Inc.)
[15]
makes the trustee’s argument a difficult one.
[5]
“Any transfer avoided under section 522, 544, 545, 547, 548, 549, or 724(a) of this title, or any lien void under section 506(d) of this title, is preserved for the benefit of the estate but only with respect to property of the estate.” 11 U.S.C §551 (2006); see also 3 Colliers on Bankruptcy ¶544.02, at 544–5 (Alan N. Resnick et al. eds., 15th ed. Rev. 2006) (“Under [§]544(a)(1) of the Code, the trustee may avoid any transfer or obligation of the debtor that is avoidable by a hypothetical creditor on a simple contract with a judicial lien on the property of the debtor unsatisfied as of the date of the commencement of the case.”).
[8]
Id. at 1209; see Dewsnup v. Timm, 502 U.S. 410, 417 (1992); see also Farrey v. Sanderfoot, 500 U.S. 291, 297 (1991).
[15]
819 F.2d 19, 23 (2d Cir. 1987) (“[T]he trustee’s subrogation powers under §§544(a)(1) and 551 do not extend to a subordination agreement protected by §510(a) of the Code. While §544(a)(1) enables the trustee in bankruptcy to step into the shoes of a hypothetical lien creditor to avoid unperfected liens . . . he can only preserve those rights which existed against the bankrupt.”).
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