The following is a case update written by the Hon. Meredith Jury (United States Bankruptcy Judge, C.D. CA., ret.), analyzing a recent decision of interest:
The United States Bankruptcy Court for the Western District of Louisiana recently ruled in a preference action against an insurance premium financier that (1) the financier’s lien on unearned premiums was perfected under Louisiana law and (2), resolving a split in authority in favor of the financier, it was sufficient to defeat a preference if the financier was fully secured on the date of each transfer, even if not fully secured on the petition date. Although the court denied summary judgment to the defendant because of disputed facts, these significant legal rulings will prevail in later proceedings. Sikes v AFCO Credit Corporation (In re Linder Oil), 2021 WL 1244536 (Bankr. W.D. LA. March 31, 2021).
To view the opinion, click here.
The debtor Linder Oil operated oil and gas wells offshore Louisiana. In 2017 it filed a chapter 7 petition and Lucy G. Sikes was appointed chapter 7 trustee. AFCO provides insurance premium financing to businesses pursuant to agreements with the insureds-borrowers under which it pays the loan proceeds directly to the insurance carrier. As collateral for the loan, the insured assigns to the lender all unearned “return” premiums (i.e., the premiums already received by the insurer but for which insurance protection has not yet been provided.) If a policy is canceled before the end of the term, the insurer must refund the unearned portion, which is the collateral of the financier. AFCO provided such financing to the debtor. When the debtor defaulted by not making monthly payments on the loan, AFCO canceled the policies and all unearned premiums were sent directly to AFCO. This payment occurred within 90 days of the petition date.
The trustee sued AFCO under various avoidance theories, the significant one for this review being section 547, the preferential transfer section. The trustee asserted that AFCO received a preference because when it received the premium refunds, it received a greater distribution from the debtor than it would have received in a chapter 7 liquidation. Both parties moved for summary judgment on the section 547 claim for relief. AFCO contended that because it possessed a perfected security interest in the unearned premiums and was fully secured at the time of the transfers, it did not receive more than it would have received in a chapter 7 liquidation. The trustee asserted two major reasons why AFCO received more than it would have in the liquidation. First, she argued that because AFCO had not perfected its lien in the refunds under Article 9 of the Uniform Commercial Code, its security had not been perfected and it was paid preferentially as an unsecured creditor. Second, she asserted that the relevant date for determining whether AFCO was fully secured was the petition date, not the transfer dates as AFCO contended. Since AFCO’s own evidence showed it was not fully secured on the petition date, the payments of the refunds were preferential.
Although the bankruptcy court did not grant summary judgment to AFCO on its preference defense because of material facts which were disputed, in a thorough and analytical opinion it ruled against both arguments made by the trustee. It found no authority that required an insurance premium financier to comply with Article 9 of the UCC in order to perfect a security interest in return premiums and ruled that under Louisiana law the security was perfected. Second, although recognizing a split in authority, the bankruptcy court distinguished Supreme Court and other cases which held that the petition date was always the critical time to determine whether a creditor was fully secured. Rather, the bankruptcy court held that for insurance premium financing, the relevant dates were the transfer dates.
The ruling on the perfection of security was straight forward because the trustee had failed to cite any case in which the court concluded that unearned insurance premiums are covered by Article 9. Although Louisiana had not weighed in on that issue, courts from other jurisdictions addressing the issue haduniformly ruled that Article 9 compliance was not necessary. The court put emphasis on uniformity in interpreting the UCC and therefore accorded great weight to those other state decisions. Being satisfied UCC recording was not required, the court then looked at Louisiana law, specifically La. Rev. Stat. section 9:3550(1) which provides that no filing of a premium finance agreement was necessary to perfect a security interest. Although that statute was written specifically to apply to consumer transactions, the court found no reason it would not be applicable here.
To defeat the trustee’s petition date argument, the court had to distinguish Palmer Clay Products Co. v Brown, 297 U.S. 227 (1936), where the Supreme Court had ruled that the petition date, not the payment date, was the relevant date to determine whether a creditor had received a preference. The court remarked that Palmerhad not been uniformly applied in cases in which the creditor is fully or partially secured, in particular when the security in question arose from insurance premium financing. The court noted two approaches. The first line of cases – referred to as the Paris add-back analysis – which calls for adding back to the finance company’s outstanding balance due from the debtor on the petition date (which here was zero) the payment received during the preference period, and then comparing that amount to the collateral remaining on that date (which here was zero, thus creating a preference). A different line of cases noted that the Palmer court only addressed payments to unsecured creditors during the preference period and hold that payments to secured creditors require a different approach. This second avenue, called the Schwinn approach, calls for determining the actual secured status of the creditor immediately prior to the alleged preferential transfer. If it was fully secured at that time, the payment to the creditor merely reduced its secured claim, and if the creditor released an equivalent value of collateral, then the payment was not a preference. The Schwinn court reasoned that if the financier was merely collecting on its collateral, then it was not receiving funds that would otherwise be available to pay unsecured creditors.
The bankruptcy court noted that the Schwinn approach had been adopted by the Tenth Circuit Bankruptcy Appellate Panel and was also consistent with Fifth Circuit jurisprudence. The Fifth Circuit has consistently drawn a distinction between secured and unsecured creditors when analyzing preference payments, a reason to legitimately distinguish Palmer and the cases which followed its strict wording. The bankruptcy court here reasoned that when AFCO received payments from its own collateral and that collateral was reduced in the equivalent amount, such money would never have been available for the unsecured creditor body as a whole on the petition date, so AFCO did not receive more than it would have in a liquidation.
I will be the first to admit that this summary does not do justice to the fine opinion by Judge John W. Kolwe in Louisiana. The space constraints of a CFN article prevented me from analyzing the issues as thoroughly, and fairly, as he did, including several issues which I did not address at all, such as whether this was a true security agreement or rather was a collateral assignment which might have ended up with a different result. (He concluded that the intent of the parties was a true security agreement.) I urge our readers with an interest in this topic to read this entire opinion, the excellent work of a very diligent bankruptcy judge.
I think he got it right. When dealing with a secured creditor paid from its collateral during the preference period, the Palmer and Paris add-back approach makes no sense. If no preferential payment had been made, the finance company would still have had a perfected security interest in the refunds on the petition date and would have been paid as a secured creditor from those funds. The unsecured creditors are not deprived of a “free from security” asset from which they might receive a dividend. The secured creditor gets what it is entitled to and what it bargained for when it made the premium financing loan. The petition date snapshot just makes no sense in this context. Moreover, the need for premium financing by many smaller businesses with restricted cash flow is paramount. The lenders need the assurance their collateral will protect them upon the borrower’s default in order to continue to provide this important financing.
This submission was written by the Hon. Meredith Jury (United States Bankruptcy Judge, C.D. CA., ret.), a member of the ad hoc group, with editorial contributions from Christopher V. Hawkins, a partner at Sullivan Hill Rez & Engel, APLC, also a member of the ad hoc group. Thomson Reuters holds the copyright to these materials and has permitted the Insolvency Law Committee to reprint them. This material may not be further transmitted without the consent of Thomson Reuters.