Security Interest Perfection Through a Chapter 11 Plan, or “Forget About Article 9 of the UCC”

David B. Wheeler
Moore & Van Allen, PLLC
40 Calhoun Street, Suite 300
Post Office Box 22828
Charleston, SC 29413-2828
(843) 579-7015
(843) 579-8727 facsimile
davidwheeler@mvalaw.com

The debtor's chapter 11 plan calls for the preservation of a secured claim secured by a blanket lien through the plan, with distributions to general unsecured creditors to be secured by "a subordinated interest in all of [the debtor's] assets." Subsequent to confirmation and the default of the debtor under the plan, the prior security claimant's UCC-1 Financing Statement lapses. What happens to the relative priority of the secured parties?

In General Electric Capital Corporation v. Dial Business Forms Inc. (in re Dial Bus. Forms Inc.),¹ the Eighth Circuit Court of Appeals affirmed the lower court rulings of the Bankruptcy and Bankruptcy Appellate Panel Courts that General Electric Capital Corporation (“GECC”), the prior secured creditor, retained its priority despite it allowing its UCC Financing Statement to lapse.

The security interest of GECC was perfected under applicable state UCC provisions prior to the debtor's bankruptcy filing. The security interest in favor of unsecured creditors, however, was evidenced by a $950,000 promissory note, security agreement, and UCC-1 Financing Statement executed and filed in conjunction with the confirmed plan. In the summer of 2000, GECC failed to file continuation financing statements for its security interest in the debtor's equipment. Under applicable state UCC law, GECC's failure to file a continuation statement rendered its security interest unperfected as against the perfected security interest in force in favor of the unsecured creditors.

Although the bankruptcy court acknowledged that under Section 9-403(2) of the UCC, the lien of the unsecured creditors would ordinarily ascend to a position of priority upon the lapse of the financing statement in favor of GECC, it ruled that GECC maintained a prior security interest over the unsecured creditors. Citing recognition of "subordination by agreement" under applicable UCC law among secured parties, the court reasoned that the unsecured creditors agreed to subordinate their security interest under the provisions of the plan of reorganization. The Court of Appeals agreed that the terms of the plan of reorganization constituted an express agreement to subordinate, and was enforceable since a chapter 11 plan "acts like a contract that binds the parties that participate in the plan."

The court next addressed whether the established priority of the parties under the chapter 11 plan was subject to defeasance in the event GECC failed to file continuation financing statements as required by applicable state law. Unfortunately, this issue was not addressed under the confirmed Plan of Reorganization. The court observed that a confirmed chapter 11 plan not only acts like a contract that binds the parties, but is also an order for the bankruptcy court. As such, it reasoned that the reviewing court should extend to the interpretation of the plan rendered by the bankruptcy court the same deference that is otherwise paid to a court's interpretation of its own order. In this case, the bankruptcy court construed the applicable provisions of the confirmed plan of reorganization as permanently fixing the relative priorities of the security interest credit, the unsecured creditors and the pre-bankruptcy security interests preserved by the plan. Citing other cases that recognize the ongoing validity of security interests without the need for additional continuation statement filings, the court ruled the bankruptcy court did not abuse its discretion in construing the plan to permanently fix the secured parties' priorities. As a result, GECC maintained its first priority security interest.

Clearly, the rights of respective classes of creditors are best observed when expressly addressed in the plan of reorganization “contract”.

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