Preserving Security Interests And Priority Status For Post-Confirmation Advances


Does a lender's prepetition priority lien extend to post-confirmation advances where the confirmed plan does not expressly provide for the continuation of the lender's priority lien? This question was recently answered by a United States district court in United States v. Lincoln Savings Bank (In re Commercial Millwright Service Corp.). The court held that:

  • absent an express provision in the confirmed plan of reorganization extending a lender's priority lien to post-confirmation advances, the lender will lose its priority status with respect to the post-confirmation advances;
  • post-confirmation promissory notes, assignments of accounts, and other documents, although putatively relating to a prepetition financing statement, are insufficient to extend a lender's priority lien to post-confirmation advances absent an express provision to that effect in the confirmed plan; and
  • under Iowa law, a filed continuation statement unsigned by the debtor is insufficient to perfect a security interest.

The Facts

The debtor, Commercial Millwright Services Corp., filed its chapter 11 petition in December 1989. The bankruptcy court confirmed the debtor's plan in July 1991. The confirmed plan provided that Lincoln Savings Bank, having perfected its prepetition security interest in April 1989, and the IRS, having perfected its tax liens in August and December 1989, would receive priority as secured creditors.

Specifically, the plan provided that:

  • the liens and encumbrances securing the bank's claim, as of the time of the filing, would remain as valid liens until paid in full;
  • the bank's superpriority lien existing as a result of postpetition financing would remain as a valid lien until paid in full; and
  • the IRS liens would remain as valid liens until paid in full. The bankruptcy court afforded the bank's liens priority over the IRS liens.

After confirmation of the debtor's plan, the bank made additional advances to the debtor. The debtor signed new promissory notes, assignments of accounts, and other documents to secure the bank's subsequent advances. Several of the promissory notes, assignments of accounts, and other documents putatively related back to the April 1989 financing statement and a continuation statement filed in March 1994. Therefore, the bank assumed that the earlier documents perfected the bank's security interest in the debtor's property with respect to the post-confirmation advances.

The debtor paid off the debts underlying the bank's superpriority and first liens in their entirety. However, the debtor did not make any payments with respect to the IRS liens. In January 1995 the debtor filed a second chapter 11 petition, and that case was converted to a case under chapter 7 in February 1996. Thereafter, the IRS commenced an adversary proceeding in the bankruptcy court to determine the nature and priority of the bank's security interest.

The bankruptcy court determined that:

  • the IRS liens, perfected in August and December 1989, were not paid in full and had priority over the bank's interest;
  • the bank's senior secured priority interest retained in the plan was terminated on the date the debtor paid its prepetition debts to the bank in full; and
  • the bank's post-confirmation advances to the debtor were unperfected.

On appeal, the bank made four distinct arguments;

  • first, the bank argued that the debtor's confirmed plan of reorganization in its initial chapter 11 case did not terminate the bank's security interest in the debtor's property;
  • second, the bank's security interest was perfected by, and related to, the financing statement filed in April 1989;
  • third, the post-confirmation promissory notes, assignments of accounts, and other documents perfected its security interest because several of the documents putatively related to the April 1989 financing statement; and
  • finally, the 1994 continuation statement perfected its interest.

Rejecting these arguments, the district court affirmed the bankruptcy court's decision.

The Plan Terminated the Bank's Security Interest

The district court held that the debtor's confirmed plan of reorganization terminated the bank's security interest. In so holding, the district court relied on sections 1141(a) and (c) of the Bankruptcy Code and the express language of the plan. Under section 1141(a), a confirmed plan of reorganization, with certain exceptions, binds the debtor and its creditors to the express terms set forth in the plan. Courts have held that pursuant to section 1141(a), a confirmed plan operates as a contract binding on parties that participate in the development of the plan. Under section 1141(c), a confirmed plan renders all property dealt with by the plan free and clear of all claims and interests of the debtor's creditors unless specifically provided otherwise. Reading sections 1141(a) and (c) together, lenders that participate in the plan process without expressly preserving their liens in the plan may be stripped of their liens upon confirmation.

In Commercial Millwright, the plan expressly provided that the bank would retain its secured priority status as to debts in existence as of the time of the chapter 11 filing until those debts were paid in full. The court held that the emphasized language clearly did not provide for an extension of the bank's priority lien to post-confirmation advances. The court distinguished General Electric Credit Corp. v. Nardulli & Sons, in which the Third Circuit affirmed the lower court's decision preserving a secured creditor's security interest. The court pointed out that in that case, even though the creditor failed to file a new financing statement following a confirmed plan of reorganization, the plan expressly acknowledged the continued existence of the security interests at issue.

Post-Confirmation Documents Not Perfected By Prepetition Financing Statement

As the district court previously determined that the bank's lien terminated upon confirmation of the debtor's plan, the post-confirmation promissory notes, assignments of accounts, and other documents could not be perfected by the April 1989 financing statement. Because the plan did not expressly provide for an extension of the bank's priority lien to post-confirmation advances, the bank made such advances at its own peril.

In addition, the post-confirmation promissory notes, assignments of accounts, and other documents, although putatively relating back to the April 1989 financing statement, could not perfect the bank's priority lien with respect to the post-confirmation advances because the April 1989 financing statement was terminated once the debtor's prepetition obligations were paid in full. Further, the court held that under Iowa law, the 1994 continuation statement was ineffective to perfect the Bank's security interest because it was not signed by the debtor. Therefore, the 1994 continuation statement could not revive the already terminated April 1989 financing statement.

Conclusion

The district court's decision makes clear that, absent the express extension of a prepetition priority lien to post-confirmation advances in a debtor's confirmed plan, a secured lender participating in the plan process will be stripped of its priority status with respect to post-confirmation advances. Therefore, lenders who contemplate advancing post-confirmation funds must be sure that the plan expressly provides for the preservation of their interests; otherwise the lending of post-confirmation funds will be at their own peril.

United States v. Lincoln Sav. Bank (In re Commercial Millwright Serv. Corp.), 245 B.R. 603 (N.D. Iowa 2000).
General Electric Credit Corp. v. Nardulli & Sons, 836 F.2d 184 (3d Cir. 1988).