Chapter 7 Trustee's Remedy Limited

Chapter 7 Trustees can and sometimes do successfully avoid creditor’s perfected liens. Typically, the avoidance opportunity arises because the lien was not perfected on a timely basis. The Bankruptcy Code provides that the avoided liens may be “preserved” for the benefit of the bankruptcy estate; this prevents a windfall to a junior lienor who would become the first lienholder courtesy of the Trustee’s success.

What happens if the lien has attached to an asset that depreciates while the Trustee’s lien avoidance adversary proceeding is pending? That question is addressed in In re Trout, Rodriguez, Trustee v. Drive Financial Services, 2010 WL 2510427 (10th Cir. June 23, 2010). In this case the trustee successfully avoided untimely filed liens on the debtors’ automobiles. After winning on liability, the Trustee asked that the Bankruptcy Court for a cash award equal to the value of the lien on the day it attached, i.e. when it was untimely lien was filed against the vehicle titles. The Bankruptcy Court said ‘no,” and instead preserved for the bankruptcy estate the previously avoided lien on the vehicles whose value fell during the litigation. The BAP affirmed and the Trustee appealed again.

The Bankruptcy Court and the BAP compared Bankruptcy Code Sections 550 (recovery of property or its value) and 551 (preservation of the avoided transfer for the benefit of the estate). The lower courts essentially held that the Section 551 was automatic and the remedies in Section 550 are only available if the liened property is not available to the trustee for the benefit of the bankruptcy estate.

The Tenth Circuit Court of Appeals joined the Sixth Circuit and held that a section 550 “recovery is permissive rather than mandatory.” The Tenth Circuit further agreed with the BAP that the remedies in Section 550 are available to a trustee in certain situations, such as when the previously liened property is gone or when the lien is worthless because the debt has been paid; in this circumstance the non-automatic relief of Section 550 (money to the trustee instead of lien preservation for the estate) is not available just because the liened property went down in value during the lien avoidance litigation.

Posted by: Vincent E. Mauer

Categories: Bankruptcy & Banking Law