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In what is apparently a one-of-a-kind ruling, a bankruptcy appellate panel of the 8th U.S. Circuit Court of Appeals has said that a lapsed security interest in collateral can still take priority over a junior lien, even if applicable state law says otherwise. This, despite a dissenting judge’s warning that a later-arriving lender who may not know of the lapsed lien could find itself in a rock-paper-scissors conflict with the other lienholders asking whose lien had priority. The decision in In re Dial Business Forms, No. 02-6009, allowed the General Electric Capital Corp. to maintain a $1 million lien on printing equipment owned by a Kansas City, Mo.-based Chapter 11 debtor, even though GE Capital didn’t file a Uniform Commercial Code (UCC) lien continuation statement before its original lien expired. On the losing side, a U.S. bankruptcy trustee noted the absence of controlling precedent and said he will appeal. The trustee, Kansas City lawyer Paul Sinclair, said, “If anybody is representing a creditor who has a lapse, they can get a lot of mileage out of this.” Carrying about $6 million in debt, Dial Business Forms filed for bankruptcy protection in 1997. According to Sinclair, in order to clear the way for Dial’s reorganization plan, a class of approximately 25 paper supplier-creditors, owed an aggregate $950,000, agreed to take a junior lien on the same collateral securing the GE Capital debt. But in February 2001, when Dial defaulted on a $175,000 payment obligation to the suppliers, Sinclair moved to enforce the suppliers’ rights, and discovered that GE’s lien had lapsed. Under Missouri UCC law, Sinclair explained, the suppliers’ subordinate lien would have supplanted the expired GE Capital lien, allowing the suppliers to foreclose on the machinery and liquidate their position. But when Sinclair tried to enforce the suppliers’ rights, he was opposed by GE Capital, whose lawyers asserted that the confirmed Chapter 11 plan supplanted the Missouri law and subordinated the suppliers’ lien permanently. Last winter, U.S. Bankruptcy Judge Arthur B. Federman of the Western District of Missouri agreed with GE. The 8th Circuit’s Oct. 1 ruling affirmed Federman’s decision, stating that the confirmed plan created a new and binding contractual agreement among the parties to the bankruptcy. Sinclair, a partner at Kansas City’s Sinclair, Haynes & Cowing, maintained that both courts misapprehended the language contained in the plan. He said that while the suppliers’ lien was described as a “subordinated interest,” that was an adjective merely describing the suppliers’ position, and not a verb indicating that the suppliers’ position would be forever junior to that of GE Capital. Noting that under Missouri law, a creditor must renew its UCC-1 lien every five years, Sinclair said that the panel’s decision was breaking the rules. Echoing dissenting Judge Barry Schermer, he said that such a decision allows for the creation of secret liens known only to the parties to the plan, not to later-arriving would-be lenders. GE attorney David Runck, senior associate at Oppenheimer Wolff & Donnelly, said the ruling was “not a change, but a clarification” of the parties’ relationship to one another. Although he conceded that federal bankruptcy law ordinarily defers to state law, he noted that in the Dial case, the court was working with a “plan-created lien” for the paper suppliers which “federalized the issue.” Runck said, “the bankruptcy appellate panel got it right,” adding that the plan had not only expressly stated that the trustee would receive a subordinated interest, but the plan went further and then defined the priority.

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