Summary of a Recent
Judicial Development in
Secured Transactions

Secret Liens are Avoidable Under 11 U.S.C. § 544(a)(1)

Walt McCarter
National AgLaw Center Research Associate

Summary of Decision

In In re R.F. Cunningham & Co., Inc., 355 B.R. 408 (Bankr. E.D.N.Y. 2006), the United States Bankruptcy Court for the Eastern District of New York held that a lien created by Ohio statute could not be enforced because the statute was overly broad and created a "secret lien" which was avoidable under 11 U.S.C. § 544(a)(1).

Background

Debtors filed for Chapter 11 relief in June 2005. Id. at 410. Champaign Landmark sold grains to the Debtor prepetition. Id. at 411. The Debtor's petition indicated that it owed Champaign Landmark approximately $140,000. Id. Champaign Landmark moved for relief from the automatic stay to enforce its lien. Id.

Arguments

Champaign Landmark argued that, by virtue of Ohio's Revised Code Annotated (ORCA) § 926.021, a statutory lien attached to the grain sold to the Debtor, so it should be entitled to relief from stay. Id.

The Debtor argued that any lien arising under Ohio statutes must be avoided pursuant to 11 U.S.C. § 544, because it would be a "secret lien" creating a priority secured claim in derogation and in detrimental harm to the rights of other creditors in violation of the statutory priority scheme of the Bankruptcy Code. Id.

Analysis and Holdings

11 U.S.C. § 362(d) allows for relief from the stay: (1) "for cause, including the lack of adequate protection"; or, (2) "with respect to a stay of an act against property . . . if the debtor does not have an equity in such property [] and such property is not necessary to an effective reorganization . . . ." Id. at 412. The court has broad discretion in determining "cause," because the term is not defined by the Code. Id. The court noted that an unsecured creditor is not entitled to adequate protection, and so relief from stay could not be granted on that basis. Id. The court stated that "[o]nly in extraordinary circumstances will an unsecured creditor be granted relief from the stay." Id.

Standing
ORCA § 926.021 provides that the Director of Agriculture has exclusive authority to enforce a lien under the statute, unless he assigns the right to a party who requests such assignment. Id. at 415. Champaign Landmark argued that it had been assigned that right in a letter from the Ohio Department of Agriculture which stated that the Department had not determined that a lien existed and so declined to intervene in the matter, but that the Department had no objection to Champaign Landmark's attempt to assert its lien. Id. The court determined that the letter constituted an assignment of the right to assert the lien, and that it was not necessary that an adversary proceeding be commenced prior to such assignment. Id. Therefore, the court held that Champaign Landmark had the requisite standing to bring its claim. Id.

Avoidability under § 544(a)(1)
The court concluded that the Ohio statute was susceptible to being avoided by 11 U.S.C. § 544 because it was too broad and gave rise to an avoidable secret lien. Id. at 416. The court interpreted the language of the statute, which stated that "a lien shall exist on all agricultural commodity assets" (emphasis added), to mean that the right to enforce a lien is not limited to the agricultural commodity for which payment is not forthcoming, but to all unencumbered funds, property and equity of the Debtor, and was therefore overly broad and subject to § 544(a)(1). Id. Under § 544(a)(1), a debtor-in-possession has the "strong arm power" to cut off unperfected security interests such as secret liens. Id. The court therefore denied Champaign Landmark's motion for relief from stay. Id. at 419.

The case was decided on November 20, 2006.